ABC is considering a project to manufacture a new product and has paid $60,000 for market research.
Question:
ABC is considering a project to manufacture a new product and has paid $60,000 for market research. Here are the details.
The project would use a warehouse that ABC already owns, but is currently leased to another company. Next year, the annual rental revenue will be $100,000. In subsequent years, annual rental revenues are expected to grow at a rate equal to annual inflation (4%).
In addition, the project requires an investment of $1,200,000 in equipment. The amortization of the equipment is calculated using the declining balance method at a constant rate of 20% (reminder: Annual amortization expense = Book value at the beginning of the year * constant rate). Abc expects to complete the project at the end of the tenth year and to sell the equipment at the end of the tenth year for $300,000.
Under normal conditions, the company expects sales of the new product to be $4,200,000 for the first year and to grow at a rate of 5% per year for subsequent years. The project will also generate additional annual revenues (special revenues that do not come directly from the sale of the product) at a value of 2% of the expected annual revenues for the new product.
The project requires an initial working capital investment of $350,000. Then, the company expects annual working capital costs to be 10% of the expected annual revenues for the new product for years 1 through 10. Finally, ABC estimates that annual manufacturing costs will be 90% of sales. The firm's tax rate is 35% and the cost of capital is 12%.
What is the NPV of ABC’s project?
Financial Theory and Corporate Policy
ISBN: 978-0321127211
4th edition
Authors: Thomas E. Copeland, J. Fred Weston, Kuldeep Shastri