A shoe manufacturer is evaluating an investment in a new factory which will produce a new line of shoes. The new factory will require an up-front investment of $1 million, which will be depreciated straight line over 5 years for tax purposes. The demand for these shoes is estimated to be 10,000 pairs in year one and will increase by 1,000 pairs per year for the next three years, after which it will remain constant for a further two years. After that production and sales will stop and the factory will need to be scrapped at a cost of $100,000. Leather and other raw materials used in the production process are estimated to cost $75 per pair. The finished goods will be sold for $115. 10% of the raw material will be held in the warehouse at any time as working capital. Production requires two people in the factory. It also requires a half-time sales employee. Due to labor market regulations, the company can only hire full-time employees. The annual salary of a full-time sales person is $40,000, and of a manufacturing person is $25,000. The corporate tax rate is 25%, paid in the year in which profits occur. You can assume that there will be no inflation, and that the company is able to use any tax shields generated by this project in the year when they are generated. The cost of capital for the project is 10%.

1)Project the free cash flows relevant to the project, explaining precisely how you arrive at those figures.

2)Should the shoe manufacturer invest in the new factory?

3)If launching this new line of shoes were to result in a reduction in sales of other shoes also produced and marketed by the shoe manufacturer, would that need to be taken into account in the project evaluation? Why, or why not?

Answer rating: 100% (QA)

1 The initial investment of 1 million will be dep reci ated straight line over 5 years for tax purposes This means that the company can deduct 200 000 ... View the full answer