Question:
The Johnson Chemical Company has just received a special subcontracting job from one of its clients. The two-year project requires the purchase of a special-purpose painting sprayer of $60,000. This equipment falls into the MACRS five-year class. After the subcontracting work is completed, the painting sprayer will be sold at the end of two years for $40,000 (actual dollars). The painting system will require an increase of $5,000 in net working capital (for spare-parts inventory, such as spray nozzles). This investment in working capital will be fully recovered after the project is terminated. The project will bring in an additional annual revenue of $120,000 (today's dollars), but it is expected to incur an additional annual operating cost of $60,000 (today's dollars). It is projected that, due to inflation, sales prices will increase at an annual rate of 5%. (This implies that annual revenues will increase at an annual rate of 5%) An annual increase of 4% for expenses and working-capital requirement is expected. The company has a marginal tax rate of 30%, and it uses a market interest rate of 15% for project evaluation during the inflationary period. The firm expects a general inflation of 8% during the project period.
(a) Compute the after-tax cash flows in actual dollars.
(b) What is the rate of return on this investment (real earnings)?
(c) Is the special subcontracting project profitable'