Capital budgeting (simpler practice problem). XYZ Inc. is considering producing a new handheld, wireless internet device....

Capital budgeting (simpler practice problem). XYZ Inc. is considering producing a new handheld, wireless internet device. Management spent $3.5 million last year on test marketing and has developed the following set of forecasts. Total cash costs (excluding depreciation) of the device will be $30 each, and they will sell them all for $100 each. They can produce and sell 55,000 devices each year for the next five years. XYZ would have to prepare a manufacturing facility and buy necessary equipment, which would cost $10 million to be spent immediately and be depreciable over 10 years using straight-line depreciation. They would have to invest $2.5 million in inventory beginning today, and this amount would not change over the life of the project. In 5 years, they will quit, dispose of the plant for $1.5 million, and recover working capital. The tax rate is 40%, the firm uses stock financing, and stockholders require a 15% return. Should XYZ accept the project? Show any needed calculations and justify the answer.

Expert Solution

since npv is negative, the project should be rejected.

Note: $3.5 million spent on marketing is sunk cost and it's not useful in decision making, so it is ignored.

ekkarill92 answered 2 years ago

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