Bedford Ltd. has accumulated a significant amount of cash from its operations over the past five years and is now looking to expand its operations. The company is considering several options and has asked you to evaluate the project that it believes makes the most sense from a strategic perspective. The company will, however, only make the investment in this project if it also makes economic sense. To help with your analysis, management has provided you with the following information. The project has the same level of risk as the ongoing operations and will require an initial investment of $1.5 million. Of this, $1 million represents the cost of a new building, and $500,000 represents the cost of new equipment. As the equipment has an estimated useful life of four years, Bedford has decided to adopt a four-year planning horizon, after which it intends to re-evaluate the investment. The building will be built on a block of land that the company purchased two years ago for $1 million but is now worth $1.75 million. The land currently has no alternative use and is sitting vacant. Land values are projected to grow at an average rate of 2% for the foreseeable future. The project will also require an additional initial investment of $350,000 in net working capital at the end of Year 1. 

After evaluating prospective revenues and costs, Bedford management has developed the following pro forma income statement for the project: Year 1 Year 2 Year 3 Year 4 Revenues $1,000,000 $1,100,000 $1,200,000 $1,250,000 Cost of goods sold 650,000 750,000 800,000 850,000 Depreciation 200,000 200,000 200,000 200,000 Operating income before tax $ 150,000 $ 150,000 $ 200,000 $ 200,000 The equipment is expected to have a salvage value of $50,000 at the end of the project, while the building is expected to be worth $650,000 at that time. The firms tax rate is 28%, its cost of capital is 11%, and the CCA rates on the equipment and building are 50% and 12%, respectively. 

There will still be assets remaining in the CCA classes, and there will be a positive balance after the deduction of the salvage value. The building acquisition qualifies for the Accelerated Investment Incentive allowing 1.5 times the CCA to be claimed in the year of acquisition. The equipment qualifies for 100% full expensing in the year of acquisition. Required: Using the net present value (NPV) method, should the project be undertaken?

Answer rating: 100% (QA)

To determine whether the project should be undertaken we need to calculate the Net Present Value NPV ... View the full answer