You are evaluating a project for a small manufacturing firm. The firm has provided the following data: the initial cost of the project is $2,500; the CCA rate is 10 percent; tax rate is 25 percent; and the cash flow in the first year is $700. Cash flows are expected to increase at 5 percent a year for four years. At the end of the fourth year, the project will end and the machinery acquired to start the project will be scrapped (zero salvage). The asset class is large and will continue. The appropriate discount rate is 7 percent.
a. Calculate beginning UCC, CCA, ending CCA, and after-tax cash flow in each year. Calculate the NPV of this project.
b. You have also obtained the following information about the best- and worst-case scenarios. In the best case, the cash flow in the first year will be $900 and will grow at 8 percent a year. In the worst case, the cash flow in the first year will be $300 and will grow at 2 percent a year. The base case was presented above. The probability of the worst case is 30 percent, best case is 15 percent, and base case is 55 percent. Calculate the expected NPV of the project.
c. You are not very confident about the growth rate assumption and the initial cash flow estimate. Do a sensitivity analysis to assess the impact of possible errors in those estimates.
Assume that growth rates could be 3 percent, 5 percent, or 7 percent and the initial cash flow could be $400, $700, or $1,000.
d. Using the base case estimates, determine the NPV break-even initial cash flow.