Problem #1: Capital Budgeting & NPV (10 points)

Project NPV United Pigpen is considering a proposal to manufacture high protein hog feed. The project would make use of an existing warehouse, which is currently rented out to a neighboring firm. The next year's rental charge on the warehouse is $50,000, and thereafter the rent is expected to grow in line with inflation at 3% a year. In addition to using the warehouse, the proposal envisages an investment in plant and equipment of $1.5 million. This could be depreciated for tax purposes straight-line over 10 years. However, Pigpen expects to terminate the project at the end of eight years and to resell the plant and equipment in year 8 for $500,000. Finally, the project requires an initial investment in working capital of $350,000. Thereafter, working capital is forecasted to be 10% of sales in each of years 1 through 7. Year 1 sales of hog feed are expected to be $3.8 million, and thereafter sales are forecasted to grow by 4% a year, slightly faster than the inflation rate. Manufacturing costs are expected to be 85% of sales, and profits are subject to tax at 35%. The cost of capital is 15.0%.

What is the NPV of Pigpen's project?