Custom Gear, Inc. is considering a new project to expand its manufacturing facilities. The project requires...

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Custom Gear, Inc. is considering a new project to expand its manufacturing facilities. The project requires an initial investment of $10 million today (the investment involves the purchase of equipment with a CCA rate of 25% and $6 million salvage value). The Accelerated Investment Incentive (A.I.I.) and declining balance depreciation apply. Management believes that the company will NOT have other assets in the same asset class when the equipment is sold in three years. Revenues (R) and expenses (E) from this project (before taxes and excluding depreciation) are shown in the table below. Not included in the expenses in the table below is an environmental impact report provided by a local consulting firm for a total cost of $40,000. The table also shows the typical net working capital requirements for Custom Gear as a percentage of expected sales revenue for the following year (the same percentages would apply to additional sales generated by the new project): Year: 0 1 2 3 $6,000,000 $7,000,000 $6,000,000 $4,000,000 $4,500,000 $4,000,000 Revenue (R) Expenses (E) Accounts Receivable (AR): 1% of Rt+1 Inventory (Inventory:): 1% of Rt+1 Accounts Payable (AP): 7% of Rt+1 NWC All NWC related cash flows will be fully reversed by the end of year three. The new project falls within Custom Gear's main line of business and is no more or less risky than the overall firm. Custom Gear's *WACC is 6% and the effective marginal corporate tax rate is 30%. What is the project's NPV? Should Custom Gear Inc. implement this project? Custom Gear, Inc. is considering a new project to expand its manufacturing facilities. The project requires an initial investment of $10 million today (the investment involves the purchase of equipment with a CCA rate of 25% and $6 million salvage value). The Accelerated Investment Incentive (A.I.I.) and declining balance depreciation apply. Management believes that the company will NOT have other assets in the same asset class when the equipment is sold in three years. Revenues (R) and expenses (E) from this project (before taxes and excluding depreciation) are shown in the table below. Not included in the expenses in the table below is an environmental impact report provided by a local consulting firm for a total cost of $40,000. The table also shows the typical net working capital requirements for Custom Gear as a percentage of expected sales revenue for the following year (the same percentages would apply to additional sales generated by the new project): Year: 0 1 2 3 $6,000,000 $7,000,000 $6,000,000 $4,000,000 $4,500,000 $4,000,000 Revenue (R) Expenses (E) Accounts Receivable (AR): 1% of Rt+1 Inventory (Inventory:): 1% of Rt+1 Accounts Payable (AP): 7% of Rt+1 NWC All NWC related cash flows will be fully reversed by the end of year three. The new project falls within Custom Gear's main line of business and is no more or less risky than the overall firm. Custom Gear's *WACC is 6% and the effective marginal corporate tax rate is 30%. What is the project's NPV? Should Custom Gear Inc. implement this project?

Answer rating: 100% (QA)

SOLUTION IN DETAILS To calculate the projects net present value NPV we need to determine the cash flows for each year and discount them to the present value using the weighted average cost of capital ... View the full answer