Question

For a new project of a company to increase the manufacturing capacity for five years, it will purchase new equipment for $1,500,000 and be housed in a building purchased eight years ago for $4,200,000. The building will be retooled for the new project at a cost of $500,000, including building permit fees of $25,000.

The purchased equipment will be depreciated using Modified Accelerated Cost Recovery System (MACRS) depreciation schedule, and sold for $250,000 in year 5.

The projected revenue for year 1 is $550,000. Subsequent year’s revenues will increase by eight percent of the preceding year’s revenues. This expansion project will result in an annual loss of revenues from an existing manufacturing operation of $100,000. Operating expenses (excluding depreciation and amortization) is estimated at 20 percent of net revenues.

Operating net working capital will rise by $250,000 and $300,000 in years 1 and 2, respectively. This investment in net working capital reverses in the final year of the project. Annual interest expense is $35,000.

Risk-Free Rate (10-Year U.S. Treasury) = 3%

The Equity Risk Premium = 4.5%

Tax Rate: 40%

Beta (β) = 1.2

Automaton’s Market Value of Equity / Total Capital ratio = 100%

Automaton’s Market Value of Debt / Total Capital = 0%

Calculate the cost of capital, net income for years 1 through 5, Free Cash Flows (FCF) for years 0 through 5, Net Present Value and Internal Rate of Return of this project?

Answer 1

1. Cost of Capital = 8.4%

2. NPV = ($313,582)

3. Internal Rate of Return = 3.14%

For detailed workings, kindly refer the screenshots below.

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