Question

ABC Corp. has decided to capitalize on the exercise fad plans to open an exercise facility in conjunction with its main yogurt and health foods store. To get the project underway, the company the company will rent additional space adjacent to its current store. The equipment required for the facility will cost $50,000. Shipping and installation charges for the equipment are expected to total $5,000. This equipment will be depreciated on a straight-line basis over its 5-year economic life to an estimated salvage value of $0. In order to open the exercise facility, ABC estimates that it will have to add about $7,000 initially to its net working capital in the form of additional inventories of exercise supplies, cash and accounts receivable for its exercise customers. During the first year of operations, ABC expects its total revenues to increase by $50,000 above the level that would have prevailed without the exercise facility addition. These incremental revenues are expected to grow to $60,000 in year 2, $75,000 in year 3, decline to $60,000 in year 4 and decline again to $45,000 during the fifth and final year of the project’s life. The company’s incremental operating costs associated with the exercise facility, including the rental of the facility are expected to total $25,000 during the first year and increase at a rate of 6% per year over the 5-year project life. Depreciation will be $11,000 per year ($55,000 installed cost assuming no salvage value, divided by 5-year life). ABC has a marginal tax rate of 40%. In addition, ABC expects that it will have to add about $5,000 per year to its net working capital in years 1, 2 and 3 and nothing in years 4 and 5. At the end of the project, the total accumulated net working capital required by the project will be recovered.

20. What is the NPV of this capital project if the cost of capital is 14%?

a. -$20,534

b. $14,237

c. -$13,879

d. $15,470

e. $22,897

21. What is the IRR of this capital project?

a. 23%

b. 14%

c. 20%

d. 9%

e. 10%

22. This project should not be accepted.

a. True b. False

Answer 1