A company projects the following unit sales for a new product in a potential 5-year project:

Year Unit sales (No. of units)

1 71,000

2 84,000

3 103,000

4 95,000

5 64,000

The firm expects to be able to sell each unit for a price of $410.

The fixed costs projected for each year (1-5) are $2,900,000, and the variable costs are projected to be $285 per unit.

The firm will need to make an initial investment of $2.3M in net working capital at the beginning of the project (year 0). After that, in years 1-4, the annual incremental changes in net working capital are projected to be 15% of the projected annual change in sales. That is:

∆NWC1 = 0.15*(Sales2-Sales1)

∆NWC2 = 0.15*(Sales3-Sales2)

∆NWC3 = 0.15*(Sales4-Sales3)

∆NWC4 = 0.15*(Sales5-Sales4)

By the end of the project (year 5), net working capital will return to its normal level.

As part of this project, the firm will also need to invest in a machine that costs $14.8M, which is considered a 7-year MACRS property for tax purposes. The MACRS depreciation table published by the IRS for this asset class is:

Year %

1 14.29%

2 24.49%

3 17.49%

4 12.49%

5 8.93%

6 8.92%

7 8.93%

8 4.46%

After 5 years, the firm will be able to sell this machine for a pre-tax salvage value of $2.96M.

The tax rate is 21% and the cash flow discount rate is 18%.

Should the firm undertake this venture?

Answer rating: 100% (QA)

Answer To determine whether the firm should undertake this venture we need to calculate the net present value NPV of the project using the given information The NPV is the difference between the prese... View the full answer