As the financial advisor to All-Star Manufacturing you are evaluating the following new investment in a manufacturing
Question:
As the financial advisor to All-Star Manufacturing you are evaluating the following new investment in a manufacturing project:
The project has a useful life of 12 years. Land costs $6m and is estimated to have a resale value of $10m at the completion of the project. Buildings cost $5m, with allowable depreciation of 10% pa reducing balance and a salvage value of $0.9m. Equipment costs $4m, with allowable depreciation of 20% pa reducing balance and a salvage value of $0.5m. An investment allowance of 20% of the equipment cost is available. Revenues are expected to be $7m in year one and rise at 5% pa. Cash expenses are estimated at $3m in year one and rise at 3% pa. The new product will be charged $400,000 of allocated head office administration costs each year even though head office will not actually incur any extra costs to manage the project. An amount of $100,000 has been spent on a feasibility study for the new project. The project is to be partially financed with a loan of $7.5m to be repaid annually with equal instalments at a rate of 4% pa over 12 years. Except for initial outlays, assume cash flows occur at the end of each year. The tax rate is 30% and is payable in the year in which profit is earned. The after-tax required return for the project is 8% pa.
Required: -
(a) Calculate the NPV. Is the project acceptable? Why or why not?
(b) Conduct a sensitivity analysis showing how sensitive the project is to revenues, the resale value of the land and to the required rate of return.
Explain your results.
Accounting
ISBN: 978-0324662962
23rd Edition
Authors: Jonathan E. Duchac, James M. Reeve, Carl S. Warren