Question

Project B: This project requires an initial investment of $20,000,000 in equipment which will require additional expense of $1,000,000 to install in the current facility. Consistent with other projects, the equipment will be depreciated using the MACRS Investment Class schedule. Once installed, the firm will need to increase inventory by $6,000,000. The project will last 6 years, but at the end of that period, the equipment will have no salvage value. During the operational period of this project, the product produced will sell for $6.50 per unit. The costs related to this product will be $4.00 per unit in variable cost and the fixed costs each year will be $1,000,000. Management has estimated that the sales volume for this project will be 3,500,000 in year 1, 4,000,000 in year 2, 4,250,000 in year 3, 4,500,000 in year 4, 4,300,000 in year 5, and 4,200,000 in year 6. Since the project has been brought under consideration through the normal channels, a discount rate equal to the WACC should be used in the project valuation.

Create a valuation spreadsheet for each of the projects mentioned above. Evaluate each project according to the following valuation methods: a. Net Present Value of Discounted Cash Flow b. Internal Rate of Return c. Payback Period d. Profitability Index

Modified Accelerated Cost Recovery System (MACRS)

Ownership Year 5-Year Investment Class Depreciation Schedule

1 20%

2 32%

3 19%

4 12%

5 11%

6 6%

Total = 100%

WACC = 12.064%

tax rate = 4%

Answer 1