You have identified a potential opportunity for WBC, which involves undertaking a project that will have a ten-year life. The project requires an initial purchase of equipment and furniture totaling $4,500,000, plus ancillary programming capability and machinery costing $1,500,000. The equipment and furniture will depreciate and have a salvage value of $500,000 at the end of the project's life, and the programming machinery will have nil salvage value at the end of the project's life. Depreciation is calculated on a straight-line basis over five years.

Information related to the project is as follows:

Sales will be $3,050,000, $4,000,000 and $5,000,000 respectively in each of the first three years of operation, expected to grow at 10 percent per annum for a further four years thereafter, and then settle to a growth of 5 percent per annum indefinitely thereafter. In the event of not undertaking this project, all of this income would be lost.

Variable costs associated with the project will be 65 percent of sales.

Fixed costs associated with the project will be $400,000 in the first year and expected to grow at 5 percent per annum thereafter.

Even though this project will not add additional expenses to head office, WBC has a policy of allocating a 'head office' charge of $200,000 a year to each major project.

Research for this project and its capability was conducted during the previous year at a cost of $300,000. It yielded valuable information.

The corporate tax rate is 30 percent.

Financiers of this type and risk in this industry are presently requiring a rate of 12 percent after corporate tax.

In order to undertake this project, WBC is considering various financing options. One option is to borrow $5,000,000 at 7 percent per annum. This loan will be paid off in 10 equal annual installments.

Required

Evaluate this project, and provide a report to WBC management discussing whether or not you recommend it should undertake the project, providing a full explanation of your recommendation.

As support for your recommendation ensure your answer includes the following:

Calculations of the NPV, IRR and the payback for the project and an analysis of the results.

Justification for the correct discount rate to be used in evaluating the project.