Question

Recent research has made possible the development of a sensing device. The company that own the Research (HALA) has just work on a process for mass-producing the device. The visibility study provides the following information:

• The estimate of annual sales would be 1,500 units if the device were priced at $85,000 per unit (in dollars of the first operating year).
• HALA would need a new manufacturing plant. This plant could be built and made ready for production within 2 year.
• HALA would need a 30-acre tract of land that would cost $2 million; the land could be purchased on December 31, 2021.
• The new manufacturing plant building would cost $6 million and would be depreciated according to the Straight-Line (SL) Method.
• A first payment of $2 million (out of the manufacturing plant building cost $6 million) would be due to the contractor on December 31, 2021, and the remaining $4 million on December 31, 2022.
• The required manufacturing equipment would be installed and would be paid for on December 31, 2022. The equipment cost is $145 million, plus a further $5 million for installation. The equipment would be depreciated according to the Double Declining Balance (DDB) Method.
• The project would require an initial investment of $15 million in working capital. This investment would be made on December 31, 2022.
• The project’s estimated economic life is 7 years (starting after the 2-year construction period).
• At the end of the project lifetime, the land is expected to have a market value of $2.5 million, the building a value of $500,000 and the equipment a value of $5 million.
• The estimated total variable manufacturing costs would $14 million yearly.
• Fixed costs would be $20 million for each year of operations.
• Since the plant would begin operations on January 1, 2023, the first in flow cash would occur on December 31, 2023.
• HALA has $5.4 million budget for research and development (R&D). The company has already expensed all of it to date on R&D.
• HALA’s market interest rate (MARR) is 25%. Any capital gains will also be taxed at 40%.

Your report must provide answers for the following:

Part one:

1. Construct the Income Statement, and Cash Flow Statement for the project
2. Determine the Net Cash Flows, PW, and IRR of the project.
3. Comment on “Gains tax” and “Sunk cost” amounts if there is any.

Part two: New Information

• By December 31, 2024 Unit prices, Variable manufacturing costs, and Fixed overhead costs are expected to increase with inflation rate of 5% yearly
• By December 31, 2023 working capital is projected to increase with inflation rate of 4% yearly over the life of the project.

1. Determine the Net Cash Flows, PW, and IRR of the project, with inflation.
2. Comment on the effect of the inflation on PW, and IRR of the project.
3. Comment on “Gains tax” and “Sunk cost” amounts if there is any.

Part three:

1. Would you recommend that the firm approve the project under the case of no inflation?
2. Would you recommend that the firm approve the project under the case of inflation?

Part four:

1. What is the break-even for demand of the project under case of no inflation?
2. What is the break-even for demand of the project under case of with inflation?

Conduct a Sensitivity Analysis for the project with inflation and comment

Answer 1