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Presentation/PPT
27/08/2022
1. Murphy Stores is a major retailer in the Midwest, deciding whether to allocate $2,500,000 million of its remaining capital budget to an investment in RFID technology to reduce merchandise theft from stores. The new business will require the company to purchase additional fixed assets that will cost $2,500,000 up front (i.e., at t=0). For tax and accounting purposes, these costs will be depreciated on a straight line basis to a salvage value of $500,000. Murphy expects to sell the assets for $300,000 in year 4 of the project (i.e., at t=4). A major factor in the decision to go ahead with the project was the results of extensive research about losses from theft and how to prevent them. Two years ago, the company spent $500,000 for this study. The project will require a $400,000 increase in inventory and a $200,000 increase in accounts payable at t=0. All working capital will be recovered in year 4 of the project (i.e., at t=4). Note that working capital does not increase with inflation. Murphy’s tax rate is 40%. The project is expected to increase sales by $10 million in year 1, and sales will continue to grow at 3% per year in years 2 through year 4. (The sales increase will be $10 million in year 1, and will grow at 3% per year starting in year 2). The operating costs, excluding depreciation are expected to be $4 million in year 1, also growing at 3% per year, in years 2 through 4. The appropriate discount rate is 12% for this project.
a. (30 pts) What are the free cash flows for this project?
b. (5 pts) What is the project’s NPV?
c. (5 pts) Should the investment be made – justify your answer.
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