Active Life Ltd has decided to manufacture a new line of running shoes based on a $50,000, two-year feasibility study. The shoes will sell for $85 a pair and has a variable cost of $30 a pair. It is estimated that the company will sell 70,000 pairs per year for the next three years. Fixed costs each year will be $700,000.

 

The initial outlay includes $9,000,000 million to build production facilities. This facility will be depreciated to zero salvage value using the prime cost method over the life of the project. At the end of the project the facilities will be sold for an estimated value of $5,000,000.

 

Active will also buy some land to build the facility. The land will cost $1,000,000. The land will not be depreciated and is expected to sell for $1,000,000 at the end of the project without any tax implication.  

 

Active Life Ltd's required payback is 2 years and the required rate of return is 12% p.a. The relevant tax rate is 30% and tax is paid in the year in which earnings are received.

 

1. Calculate the incremental cash flows of the new project for each year (Y₀ to Y₃ inclusive).
2. Calculate the payback period of the project. (Show answer correct to 4 decimal places.)
3. Calculate the net present value (NPV) of the project. (Show answer correct to 2 decimal places.)
4. Calculate the present value index of the project. (Show answer correct to 4 decimal places.)
5. Should the company accept this project? Why or why not?

Answer rating: 100% (QA)

ANSWER To calculate the incremental cash flows of the new project for each year Y0 to Y3 inclusive we need to consider the revenues costs and tax impl... View the full answer