Accurate Blasting Corporation (ABC), a company with profitable ongoing operations, is considering a major project on which the company has already incurred $850,000 in research and development costs. The vice-president in charge of finance has provided you with the following data and worksheet and asked you to determine, using an NPV analysis, if the project should be undertaken. She has also hinted your future with the company hinges on a successful analysis of the project. Data Sheet: Company's tax rate = 40% Company's opportunity cost of capital = 15% Net working capital requirements of the project if it is accepted: Year 0 $150,000 Year 1 $250,000 Year 2 $250,000 Year 3 $250,000 Year 4 $250,000 Year 5 $0 New specialized equipment purchases required for the project total $12,000,000. At the end of the project, it is expected that the equipment can be sold to a competitor for $900,000. This equipment will be depreciated using a 10-year depreciation schedule. During each year of the project it is expected that incremental revenues of $18,000,000 and incremental expenses of $10,000,000 will be generated. Assume that these pre-tax amounts occur at the end of each of the five years. A labor shortage will occur at each of the other ABC factories resulting in increased labor costs in those factories. The expenses are expected to be $750,000 at the end of the first year and are expected to grow by 3% per year for the remainder of the project. What is the NPV of the project and what is your recommendation?
Accurate Blasting Corporation (ABC), a company with profitable ongoing operations, is considering a major project on which the company has already incurred $850,000 in research and development costs. The vice-president in charge of finance has provided you with the following data and worksheet and asked you to determine, using an NPV analysis, if the project should be undertaken. She has also hinted your future with the company hinges on a successful analysis of the project. Data Sheet: Company's tax rate = 40% Company's opportunity cost of capital = 15% Net working capital requirements of the project if it is accepted: Year 0 $150,000 Year 1 $250,000 Year 2 $250,000 Year 3 $250,000 Year 4 $250,000 Year 5 $0 New specialized equipment purchases required for the project total $12,000,000. At the end of the project, it is expected that the equipment can be sold to a competitor for $900,000. This equipment will be depreciated using a 10-year depreciation schedule. During each year of the project it is expected that incremental revenues of $18,000,000 and incremental expenses of $10,000,000 will be generated. Assume that these pre-tax amounts occur at the end of each of the five years. A labor shortage will occur at each of the other ABC factories resulting in increased labor costs in those factories. The expenses are expected to be $750,000 at the end of the first year and are expected to grow by 3% per year for the remainder of the project. What is the NPV of the project and what is your recommendation?
Chapter10: Capital Budgeting: Decision Criteria And Real Option
Section: Chapter Questions
Problem 23P
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Transcribed Image Text:Accurate Blasting Corporation (ABC), a company with profitable ongoing operations, is
considering a major project on which the company has already incurred $850,000 in
research and development costs. The vice-president in charge of finance has provided you
with the following data and worksheet and asked you to determine, using an NPV analysis,
if the project should be undertaken. She has also hinted your future with the company
hinges on a successful analysis of the project.
Data Sheet:
Company's tax rate = 40%
Company's opportunity cost of capital = 15%
Net working capital requirements of the project if it is accepted:
Year 0 $150,000
Year 1 $250,000
Year 2 $250,000
Year 3 $250,000
Year 4 $250,000
Year 5 $0
New specialized equipment purchases required for the project total $12,000,000. At the end
of the project, it is expected that the equipment can be sold to a competitor for $900,000.
This equipment will be depreciated using a 10-year depreciation schedule. During each
year of the project it is expected that incremental revenues of $18,000,000 and incremental
expenses of $10,000,000 will be generated. Assume that these pre-tax amounts occur at the
end of each of the five years.
A labor shortage will occur at each of the other ABC factories resulting in increased labor
costs in those factories. The expenses are expected to be $750,000 at the end of the first
year and are expected to grow by 3% per year for the remainder of the project.
What is the NPV of the project and what is your recommendation?
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