You are examining the viability of a capital investment in which your firm is interested. The project will require an initial investment of $500,000 and the projected revenues are $400,000 a year for five years. The projected cost-of-goods-sold is 40% of revenues, and the tax rate is 40%. The initial investment is primarily in plant and equipment and can be depreciated straight line over five years (the salvage value is zero). The project makes use of other resources that your firm already owns:
• Two employees of the firm, each with a salary of $40,000 a year, who are currently employed by another division, will be transferred to this project. The other division has no alternative use for them, but they are covered by a union contract that will prevent them from being fired for three years (during which they would be paid their current salary).
• The project will use excess capacity in the current packaging plant. Although this excess capacity has no alternative use now, it is estimated that the firm will have to invest $250,000 in a new packaging plant in Year 4 as a consequence of this project using up excess capacity (instead of Year 8 as originally planned).
• The project will use a van currently owned by the firm. Although the van is not currently being used, it can be rented out for $3,000 a year for five years.
The book value of the van is $10,000, and it is being depreciated straight line (with five years remaining for depreciation).
• The discount rate to be used for this project is 10%.
a. What (if any) is the opportunity cost associated with using the two employees from another division?
b. What (if any) is the opportunity cost associated with the use of excess capacity of the packaging plant?
c. What (if any) is the opportunity cost associated with the use of the van?
d. What is the after-tax operating cash flow each year on this project?
e. What is the NPV of this project?