As a result of the success of her concerts in the US$,$ Taylor Swift is considering adding a new line to her product mix. Production would be set up in an unused space in her companys plant. She would have to buy new machinery. The price of the machinery is $$5,000,000$ as well as $$100,000$ in shipping and insurance charges would be required for the equipment. It would also cost an additional $$300,000$ to install the equipment. Further, inventories would have to be increased by $$25,000$ to handle the new line. Accounts payable would have to rise by $$5,000.$ The machinery has an economic life of $4$ years, will be depreciated using MACRS $3-$year. The machinery is expected to be worthless at the end of four years but they anticipate being able to sell it for scrap for $$25,000$ after $4$ years of use. The $3-$year class MACRS depreciates at $33\%,45\%,15\%,$ and $7\%$ over years $1,2,3$ and $4$ respectively.

The new machine would generate incremental sales of $500,000$ units in the first year. However, sales are forecast to decrease $20\%$ every year for the next three years when the product line is discontinued. The incremental cost is $$5\mathrm{.}00$ per unit, excluding depreciation. Each unit can be sold for $$10.$ The firms tax rate is $20\%,$ and the cost of capital is $10\%.$

Taylor is a world class performer but not an expert on capital budgeting. As a result, she has hired you to help her with this decision. Should Taylor add the product line? You must make a persuasive presentation to Taylor either to accept or reject this new product line. Taylor also has expressed concern regarding some of the estimates that are used in the forecast. For example, she expressed concern regarding the incremental unit cost and the cost of capital. You must address Taylors concern with respect to the incremental unit cost and the cost of capital in your answer. Taylor is expecting at least two metrics in your answer.

Show how to calculate the NPV and IRR through Excel functions.

Answer rating: 100% (QA)

To assess whether Taylor Swift should add the new product line we will calculate the Net Present Value NPV and Internal Rate of Return IRR of the proj... View the full answer