Problem #7 Capital Budgeting (23 marks)

Homemade Home Cooling Inc. is considering in investing in new solar cooling units for office buildings.A market survey was undertaken at a cost of $150,000 that indicated that the firm would be able to sell 510 units per year for the next 4 years at a selling price of $10,000 per unit.Variable costs are estimated at $5,000 per unit and fixed costs have been estimated at $610,000 per year.The new sales will result in the eroding of existing before tax earnings by $25,000 per year.The cost of the new equipment to manufacture the new product consists of $1,000,000 for the manufacturing equipment and an additional cost of $200,000 for new packaging equipment.Both assets will be recorded in class 8 asset pool which uses a 20 percent CCA rate.The firm has many assets in this asset class.Installation of the new assets will result in the firm incurring installation costs of $250,000. The firm will need to spend $1,200,000 in new inventory, accounts receivable will increase by $300,000 and accounts payable will increase by $400,000.At the end of the four year project, the assets will be salvaged for the undepreciated capital cost. The cost of capital for the firm is 20 percent and the corporate tax rate is 40 percent.

a.Calculate the initial investment.Clearly label and show your work! (3 marks)

b.Calculate the present value of the after-tax cash flows for the operation of the firm.Clearly label and show your work! (3 marks)

c.Calculate the capital cost allowance and the undepreciated capital cost for each of the four years of the project.Clearly label and show your work! (3 marks)

d.Calculate the present value of the tax shield benefit.Clearly label and show your work! (3 marks)

e.Calculate the present value of the after-tax terminal cash flows.Clearly label and show your work! (3 marks)

f.Calculate the NPV for the project and state your conclusion.Clearly label and show your work! (2 marks)

g.Calculate the profitability index for the project.Clearly label and show your work! (2 marks)

h.Calculate the IRR of the project.Clearly label and show your work! (4 marks)