# Question

The Kumar Corporation, a firm in the 34 percent marginal tax bracket with a 15 percent required rate of return or discount rate, is considering a new project. This project involves the introduction of a new product. This project is expected to last five years and then, because this is somewhat of a fad product, it will be terminated. Given the following information, determine the net cash flows associated with the project, the project’s net present value, the profitability index, and the internal rate of return. Apply the appropriate decision criteria.

Cost of new plant and equipment: ..... $ 9,900,000

Shipping and installation costs: ...... $ 100,000

Unit sales:

Year Units Sold

1 .......... 70,000

2 .......... 100,000

3 .......... 140,000

4 .......... 70,000

5 .......... 60,000

Sales price per unit: $280/unit in Years 1–4, $180/unit in Year 5

Variable cost per unit: $140/unit

Annual fixed costs: $300,000

Working capital requirements: There will be an initial working capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will equal 10 percent of the dollar value of sales for that year. Thus, the investment in working capital will increase during Years 1 through 3, then decrease in Year 4. Finally, all working capital is liquidated at the termination of the project at the end of Year 5.

The depreciation method: Use the simplified straight-line method over five years. It is assumed that the plant and equipment will have no salvage value after five years.

Cost of new plant and equipment: ..... $ 9,900,000

Shipping and installation costs: ...... $ 100,000

Unit sales:

Year Units Sold

1 .......... 70,000

2 .......... 100,000

3 .......... 140,000

4 .......... 70,000

5 .......... 60,000

Sales price per unit: $280/unit in Years 1–4, $180/unit in Year 5

Variable cost per unit: $140/unit

Annual fixed costs: $300,000

Working capital requirements: There will be an initial working capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will equal 10 percent of the dollar value of sales for that year. Thus, the investment in working capital will increase during Years 1 through 3, then decrease in Year 4. Finally, all working capital is liquidated at the termination of the project at the end of Year 5.

The depreciation method: Use the simplified straight-line method over five years. It is assumed that the plant and equipment will have no salvage value after five years.

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