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Presentation/PPT
27/08/2022
. Mandarin Ltd. is currently considering starting a new line of business. Since the risk profile of this new business line is quite different from that of its current business, Mandarin has decided to use a cost of capital of 11% in assessing the viability of the new business line. Mandarin has also decided to use a 6-year planning horizon, which coincides with the projected useful life of the production equipment required for the new business.
To start the business, Mandarin will need to spend $10 million on new production equipment. Management estimates that the equipment will have a salvage value of $1.25 million at the end of its useful life. The applicable CCA rate on the production equipment is 12.5%. Mandarin intends to run the new business using half of the building where it is operating its current business. The space designated for the new business is currently unused. Costs associated with the use and maintenance of the building have been stable at $500,000 per year over the past several years, but these are expected to increase to $700,000 with the new business. The new business will also require an additional investment in net working capital of $100,000.
As a part of its business plan, management has generated the following projected income statements for the new business:
Year 1 Year 2 Years 3–6
Revenues $ 9,000,000 $ 11,500,000 $ 13,000,000
COGS (6,000,000) (7,500,000) (8,400,000)
Depreciation (2,850,000) (2,350,000) (1,200,000)
EBIT $ 150,000 $ 1,650,000 $ 3,400,000
Assuming that Mandarin’s marginal tax rate is 34%, determine whether Mandarin should start the new business line using the net present value (NPV) method. (8 marks)
YearEBITTaxDepreciationFixed capital inventmentIncrease in net working capitalFree cash flowPresent valueNet persent value 0 12345150000 1650000 3400000 3400000 340000051000 561000…
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