The Great Eastern Toy Company management is considering an investment in a new product. It would require the acquisition of a piece of equipment for $16 million with a ten-year operational life, providing regular maintenance is carried out.
Salvage value of the equipment is estimated at $800,000. The product's economic life is expected to be five years, with annual revenues estimated at $10.8 million during this period. Raw material for the new product is estimated at $95 per unit produced, and an inventory equivalent to one month's production, or 3,000 units, would be needed. Direct costs of manufacture are expected to be $130,000 per month. Work-in-progress and finished goods inventories would rise by $150,000.
For tax purpose, fixed assets must be depreciated according to the straight-line method. The corporate income tax rate is 40 percent and so is the capital-gain tax rate. The company's cost of capital is 12 percent.
a. Based on the above data, set out the cash flows expected from the project.
b. What is the net present value of the project?

  • CreatedMarch 27, 2015
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