Question

A client of your financial consulting firm is considering a new investment proposal that involves manufacturing and selling a unique type of financial calculator. As with a standard calculator, the user can type in any number, but this calculator has only one function key that multiplies the number typed in by 1.08 -- to figure out the cost of an item inclusive of the 8% state sales tax. Your client has already identified a fully operational calculator manufacturing plant that is available for lease, and eleven key sales districts. Show your work, do not use Excel.

You have assembled the following information:

• Revenues, all of which are taxable, are expected to be $140,000, $120,000, and $100,000 in each of the three years of the project's life.

• The cost of sales is expected to be 70% of sales revenue. • Lease payments for the manufacturing plant will be $16,000 per year.

• A new machine will have to be purchased at a cost of $60,000.

• The new machine will be depreciated down to its salvage value of $30,000 over the three- year life of the project. The machine is expected to be sold at the end of the third year for the salvage value.

• You estimate that working capital required in each year is expected to be 30% of revenues in the following year.

• The marginal tax rate of the client is 35%. • The required return on investments this risky in the past is 15%.

1. Calculate the NPV of the project. Should you advise your client to accept or reject the project?

2. Now, suppose after careful calculations, you realized the following changes to the project. Calculate the new NPV. Should your client accept or reject the project with the revised information?

   • □ The new machine will be depreciated down to zero salvage value over the three year life of the project.

   • □ After the initial investment in working capital of $30,000 in the same year that you purchase the machine, the level of working capital stays the same in subsequent years until it is recovered when you end the project.

   • □ The marginal tax rate is 40%.

Answer 1

Answer with working is given below