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In: Finance

Your firm is contemplating a capital investment in equipment that will enable a new product line....

Your firm is contemplating a capital investment in equipment that will enable a new product line. Last month you paid a consultant $50,000 to analyze the feasibility of the product line, but now you have tasked your financial analysis group with evaluating the product line. The equipment will cost $2,000,000 (payable today). The equipment will be depreciated straight line to $0 over the two year operating period. You believe that the equipment will have a $650,000 salvage value at the end of year 2. The expected annual revenues are $13,000,000, annual cash expenses will be $10,250,000. To start production, an upfront investment in net working capital of $50,000 will be required (assume full recovery at the end of the operating period). With a tax rate of 21% and a discount rate of 10%, should this expansion be undertaken?

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Expert Solution

Last month you paid a consultant $50,000 to analyze the feasibility of the product line - this cost is a sunk cost as it has been incurred, irreversible and can't be undone. Hence this cost is irrelevant for this NPV analysis.

Please see the table below. Please be guided by the second column titled “Linkage” to understand the mathematics. The cells highlighted in yellow contain your answer. Figures in parenthesis, if any, mean negative values. All financials are in $. Adjacent cells in blue contain the formula in excel I have used to get the final output.

Since NPV of the project is +ve, this expansion should be undertaken.

jeff jeffy answered 2 weeks ago
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