Background information for Questions $3,4$ and $5$

Your company XYZ is considering an expansion capacity for its best$-$selling product with

growing demand into the foreseeable future. The project that has an economic life of $3$ years.

The initial cost $($at Year $0)$ of a machine is $$50,000,$ and it can be sold after $3$ years for a salvage

value of $$13,000.$ At Year $0,$ there is another investment of $$12,000$ for inventories and

receivables, but these funds will be completely recovered when the operation is closed at the end

of the project. The project will produce sales revenue of $$50,000$ per year for $3$ years, with the

first sales revenue happens at Year $1.$ The variable operating costs $($excluding depreciation$)$ will

be $40$ percent of sales revenue throughout the project life and there is no fixed cost. Operating

cash flow will begin one year from today at Year $1.$ The depreciation schedule allows

depreciation expenses for this type of machine to be $$30,000,$$$5,000$ and $$5,000$ at Year $1,2,$

and $3$ respectively. The company has a $40$ percent tax rate. Currently, its capital structure consists

of $22\%$ debt, and $78\%$ common equity but its target capital structure comprises of $25\%$ debt and

$75\%$ common equity. Currently its debt is in one single outstanding issue of corporate bond with

a coupon rate of $7\mathrm{.}5\%$ and a yield$-$to$-$maturity of $9\%.$ The company's common stock has a beta

of $1\mathrm{.}65.$ The Treasury bond yield is $7\%$ and market risk premium is $8\%.$ For higher$-$risk projects,

XYZ Company typically adds $3$ percent to its overall WACC, and for lower$-$risk projects, it

deducts $3$ percent from its overall WACC to calculate the risk$-$adjusted discount rate.

Question $3$

Derive the incremental cash flows of this project. Show your work in detail.

$(15$ marks$)$

Question $4$

Calculate the appropriate discount rate for the evaluation of this project.

$(10$ marks$)$

Question $5$

Based on Net Present Value, should you accept this project? Explain your logic, supported by

detailed calculation.

$(5$ marks$)$