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How would like help understanding this question if possible ASAP.
You are hired to perform a project analysis for your client, a small (but very profitable) producer of computer parts. To compensate you for your valuation services, your contract stipulates that the company will pay you a one time – tax deductible! – fee of $20,000 at T=0.
– For the next 8 years, the client would be producing special gaming cords. In year 1, the sales will be 11,000 cords. Every year thereafter, the number of cords sold is expected to increase by 500 per year.
– The price per cord is expected to be $15 the first year; and the price is expected to increase 3% per year thereafter. The variable costs (i.e. the material) are expected to be 30% of the revenues every year. In addition, the client is expected to pay fixed costs of $100,000 per year.
– The project requires initial capital asset investment (at T=0) – a production machine worth $240,000. The value of the production machine is to be depreciated straight-line to zero over 16 YEARS (note: even though the project takes only 8 years, it is very well possible that the time of depreciation may be completely different from the maturity of the project.). It is expected that the production machine will be sold after 8 years for the (salvage) price of $80,000.
– In addition, the project requires the purchase of land worth $500,000 to be paid in cash. The land is not to be depreciated.
– Initial net working capital (NWC) investment is $10,000 (to be paid immediately) and NWC levels are expected to increase by $1,000 throughout the life of the project (that is, every year, the NWC level is supposed to be $1,000 higher than the previous year’s level).
– The tax rate is 35% and the required rate of return is 9%.
A) If the company decides to undertake the project, what are the levels of total free cash flows associated with the projects in years 0 through 8?
B) What is the NPV of the project?
C) What is the Internal Rate of Return (IRR) of the project?
D) Ultimately, should the company undertake this project?
E) Assume a little different scenario –
the local community will donate the land for the project. The contract stipulates that upon completion of the project, the land shall be returned back to that community (free of charge) by your client.
How much will the NPV of the project change under these new circumstances? Should your client undertake the project in this case? Why or why not?
F) Go back to the original project you analyzed in parts A through D. Consider this scenario: IF the company decides to produce the NEW product, the sales of the existing company’s products will benefit. It can be estimated that the (total) FCF generated by the EXISTING products of the company would increase by $15,000 per year for Years 1 through 8, if the gaming connector cord is introduced. What is the project’s NPV under these new circumstances? Should the company undertake the project in this case? Why or why not?
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