Question

Suppose that you are a consultant for Avero Inc, a manufacturer of document cameras. Due to many people working from home as a result of COVID restrictions, the market for document cameras is growing rapidly.  Avero has hired a marketing firm to analyze the market, at a cost of $175,000.  Based on the survey, it has been projected that the firm will be able to sell 5,100, 5,800, 6,400 and 4,700 units each year for each of the next 4 years, respectively.  A price of $425 can be charged for each mid-priced document camera. However, the life of the project is likely to be four years, as the demand for this model of document cameras is likely to be zero at that time.  The fixed costs are estimated to run $345,000 per year, and variable costs are projected to 15% of sales.  A purchase of capital equipment in the amount of $2.65 million will be required at the beginning of the project (time 0). The equipment will be depreciated according to the MACRS weights in the table below.  At the end of the project, the equipment is projected to be able to be sold at $395,000.

MACRS schedule (from Table 9.4 in your text)

Year       depreciation rate

1.    33.33
2. 44.45
3. 14.81
4. 7.1

An initial investment of net working capital of $125,000 will be required at time 0, and is assumed to be fully recovered at the end of the project. Suppose the corporate tax rate is 34% and the firm’s cost of capital is 13%.

Should the firm proceed with the project? Be sure to include all relevant calculations. You may do this problem in a spreadsheet, but obviously you should be able to do a similar problem in the in-class final. Be clear to show how you arrived at your calculations.

Answer 1

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