Case #$3$: Evaluating a Single Project Using NPV Analysis $(15$ marks$)$

Go Video, a manufacturer of video recorders, is considering a proposal to enter a

new line of business. In reviewing the proposal, the company's CFO is considering

the following facts:

The new business will require the company to purchase additional fixed assets that

will cost $$800,000$ at $t=0.$ For tax and accounting purposes, these costs will be

depreciated on a straight$-$line basis over four years with zero salvage value. $($i$.$e$.,$

Annual depreciation will be $$200,000$ per year at $t=1,2,3$ and $4).$

The project will require a $$400,000$ increase in net operating working capital at $t$

$=0,$ which will be recovered at $t=4.$ The company's marginal tax rate is $30$

percent.

Sales are expected at $1\mathrm{.}5$ million units per year. Price per unit is $$2\mathrm{.}5,$ variable cost

per unit is $$1\mathrm{.}3,$ and fixed costs are $$1$million per year.

If the project's cost of capital $($WACC$)$ is $12$ percent per year, is this proposal a

sound one? Justify your answer.

Answer: