Polycorp Steel Division is considering a proposal to purchase a new machine to produce a new product for a eight-year contract. The new machine will cost $10 million. The firm intends to use $6,000,000 in equity and $4,000,000 in debt to finance the project. The debt will be repaid over eight years in equal annual, end of year payments. The interest rate is 5%pa. The machine has an estimated life of 8 years for accounting and taxation purposes. Installation will cost a further $500,000. Installation costs are capitalised and added to the cost of the machinery for depreciation and investment allowance calculations. The contract will not continue beyond eight years and the equipment has an estimated salvage value at the end of eight years of $800,000. The tax rate is 30 percent and is payable in the year in which profit is earned. An investment allowance of twenty percent on the outlay plus installation costs is available (only in the first year). The after-tax cost of capital is 9.25%pa. Addition current assets of $400,000 are required immediately for working capital to support the project. Assume that this amount is recovered in full at the end of the life of the project. The new product will be charged $400,000 of allocated head office administration costs each year even though head office will not actually incur any extra costs or cash flows to manage the project. This is in accordance with the firm’s policy of allocating all corporate overhead to divisions. The Division will incur extra marketing and administration cash outflows of $650,000 per year for the project. An amount of $200,000 has been spent on a pilot study and market research for the new product. This account has not been paid but will have to be paid whether the project is accepted or not. The projections provided are based on this work. Projected sales in the first year for the new product are 80,000 units at $140 per unit per year. Unit sales are expected to increase by 4%pa for years 2 and 3. and then by 2% pa for the remaining years. Cash operating expenses are estimated to be 76% of sales (excludes marketing and administration, and head office items). Except for initial outlays, assume cash flows occur at the end of each year (unless otherwise stated). Assume diminishing value depreciation for tax. Conduct a Project Evaluation in Excel. Calculate the NPV, IRR of the Project.
F3.
Polycorp Steel Division is considering a proposal to purchase a new machine to produce a new product for a eight-year contract. The new machine will cost $10 million. The firm intends to use $6,000,000 in equity and $4,000,000 in debt to finance the project. The debt will be repaid over eight years in equal annual, end of year payments. The interest rate is 5%pa. The machine has an estimated life of 8 years for accounting and
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