A Corp. is considering a four year new proxied with the following information: the feasibility study cost
Question:
A Corp. is considering a four year new proxied with the following information: the feasibility study cost the company $75.000. The company needs to buy machines to start the project which will cost 54 Million. These machine of be depreciated straight-line to zero over its four- year life, after which time the company can sell them at the end of the project for $700.000. The new project is expected to generate sales revenue of S1.2 million the first year, $2.3 million the second year, 1.9 million in the third year, and $1.3 million in the fourth year. For each year (1 to 4) the variable and fixed costs are expected to equal 60 percent of sales revenue. The new project is expected to reduce (decrease) the after tax cash flows of the company's existing projects by $300,000 a year (t-1, 2, 3, 4). The optimal capital structure is estimated as 35 percent debt, and 65 percent equity. The cost of debt is estimated to be 8.7 percent (before tax). The risk free rate is 3 percent; the market risk premium is 7 percent, and the beta for the company is 1.3. The corporate tax rate is 30 percent.
a. Using the NPV method, Should the company accept this project or not? and why? Please show all your calculations.
b. Using the Internal rate of return (IRR) method, Should the company accept this project or not? and why? Please show all your calculations.
Financial and Managerial Accounting
ISBN: 978-1285078571
12th edition
Authors: Carl S. Warren, James M. Reeve, Jonathan Duchac