You have been hired as consultants to XrayGlasses Corporation (XGC). XGC is in the process of deciding whether to invest in a new production facility. The new facility will enable it to produce and sell X-ray machines to airports. The manufacturing and marketing process is not very different from their current line of business. The management of XGC has produced certain estimates about the new facility. Review the estimates to:
a. Calculate beginning UCC, CCA, and ending UCC each year.
b. Calculate investment, opportunity cost, and changes in net working capital each year.
Note that these items are not subject to tax.
c. Calculate revenue and cost of X-ray machines project each year and the lost revenue and saved cost of X-ray glasses each year.
d. Calculate after-tax cash flows each year.
e. Determine the appropriate discount rate for the X-ray machines project.
f. Determine the NPV of this project to Xray Glasses Corporation. Make a recommendation, with supporting arguments, to the management of Xray Glasses about the project.
• Cost of the machinery: $45,000; installation costs: $15,000
• Life of the project: five years; the expected salvage value of the machine is $2,000
• An environmental assessment of the building site that is already paid: $200,000
• Charles LeCrook has offered XrayGlasses $150,000 for the building. Xray Glasses paid $45,000 for the building 10 years ago and spent $50,000 last month on renovations.
• The CCA rate on the machinery is 25 percent, and there are other assets in the pool.
At the end the project, the pool is not expected to be closed. The firm’s tax rate is 35 percent.
• Currently work-in-progress inventory is $65,000. This is expected to increase by $2,000 immediately and to remain at that level for the life of the project. This inventory will be sold at the end of the project.
• Currently accounts receivable are $15,000. This is expected to increase by $3,000 by the end of year 1. The higher level of accounts receivable is expected to continue until the end of the project, at which time the accounts will be paid in full.
• Currently accounts payable are $25,000. This is expected to increase by $2,000 by the end of year 1. The higher level of accounts payable is expected to continue until the end of the project, at which time the accounts will be paid in full.
• XGC expects to sell 25 machines in year 1, 30 in year 2, and 40 machines per year for years 3 to 5.
• Variable costs are expected to be $5,000 per machine; the expected sales price is $50,000.
• Annual fixed costs for the firm are currently $900,000 per year and will rise to $930,000 during the project.
• Currently the firm sells 400 pairs of x-ray glasses to airport security guards each year.
These sales are expected to disappear when the x-ray machines enter service. The price of a pair of glasses is $550 and the cost of production is $50.
• The company will have to borrow to finance the start-up of the project. The expected interest expense is $5,000 per year. Each year the firm will have to repay $3,000 of the principal of the loan. Overall, the firm expects to remain at its optimal capital structure.
• Currently the firm pays $25,000 in dividends. This is expected to increase to $28,000 during the life of the project.
• The yield to maturity of the firm’s debt is 5 percent, the cost of equity is 14 percent, and the WACC is 10 percent.