ABC Corporation is considering an expansion project. The proposed project has the following features:(8 points) The proj...
ABC Corporation is considering an expansion project. The proposed project has the following features:(8 points)
The project has an initial cost of $2,000,000 (machine: $1,800,000, insurance: $40,000,
shipping $60,000, modification: $100,000) --this is also the amount which can be
depreciated using the following 3 year MACRS depreciation schedule:
| Year | Depreciation Rate |
| 1 | 33% |
| 2 | 45 |
| 3 | 15 |
| 4 | 7 |
The sales price is expected to increase by 3 percent per year due
to
inflation.
The variable cost is expected to increase by 4 percent per year.
The fixed cost will be $50,000 per year for the next four years. (No fixed cost increase)
Number of units sold will grow by 10 percent every year.
If the project is undertaken, net working capital would have to increase by an amount
equal to 10% of sales revenues. This net operating working capital will be recovered
at the end of the project’s life (t = 4). (You must consider an inflation effect.)
If the project is undertaken, the company will sell additional 200,000 units in year one (t = 1). Unit price at the end of the Year 1 is $12.
Unit price is $12 and variable unit cost is $5 at the end of the Year 1.
The company’s tax rate is 40 percent.
The company has no debt.
At the end of Year 4, the project’s economic life is complete, but the company can sell the machine at $20,000 (market value of salvage).
The project’s WACC = 10 percent.
What is the project’s net present value (NPV)?
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