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Question: Artistic Clothing is considering an extension project which includes the construction of a new manufacturing...

Question: Artistic Clothing is considering an extension project which includes the construction of a new manufacturing warehouse. The required initial investment for the construction is $2 million. the warehouse will be depreciated over 10 years on a straight-line basis with no residual value at the end of year 10. Also, company also plans to use its own land for the project which is currently hired to other company to use as a warehouse. The estimated rental income that will be missed over the project life is $300,000 valued as of today. To start the production, Artistic Clothing needs to invest in net working
capital the total amount of $200,000 at the beginning of the project. This investment will be recovered at the end of the project.

Company also expects to generate an annual revenue of $650,000, its associated cost of sales and operating expense are $250,000. Tax rate is 30%.

a. Determine the cash flows of the project from year 1 to year 10.

b. If company requires a rate of return of 10% from the project, should this project be accepted?

c. Calculate the payback period. If the company requires a payback period of less than 6 years, should the project be accepted?

Solutions

Expert Solution

a. Cash flows:
Year Contribution reced. dep IBT IAT Cash Flow discount 10% PV
0 -2200000 -2200000 1 -2200000
1 400000 200000 200000 140000 340000 0.909 309060
2 400000 200000 200000 140000 340000 0.826 280840
3 400000 200000 200000 140000 340000 0.751 255340
4 400000 200000 200000 140000 340000 0.683 232220
5 400000 200000 200000 140000 340000 0.621 211140
6 400000 200000 200000 140000 340000 0.564 191760
7 400000 200000 200000 140000 340000 0.513 174420
8 400000 200000 200000 140000 340000 0.467 158780
9 400000 200000 200000 140000 340000 0.424 144160
10 400000 200000 200000 140000 340000 0.386 131240
working capital 200000 0.386 77200
NPV -33840
b) No, the project should not be accepted as NPV is negative.
Moreover, off-project the rental incomes present value is $300000.
c) The payback period of the project is $2m/0.4m = 5 years and as per
criteria of acceptance lower to 6 years, the should be accepted.

jeff jeffy answered 1 year ago
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