As a financial analyst, you must evaluate a proposed project to produce printer cartridges. The equipment would cost $55,000, plus $10,000 for installation. Annual sales would be 4,000 units at a price of $50 per cartridge, and the project's life would be 3 years. Current assets would increase by $5,000 and payables by $3,000. At the end of 3 years, the equipment could be sold for $10,000. Depreciation would be based on the MACRS 3-year class; so the applicable rates would be 33%, 45%, 15%, and 7%. Variable costs would be 70% of sales revenues, fixed costs excluding depreciation would be $30,000 per year, the marginal tax rate is 40%, and the corporate WACC is 11%.
As a financial analyst, you must evaluate a proposed project to produce printer cartridges. The equipment would cost $55,000, plus $10,000 for installation. Annual sales would be 4,000 units at a price of $50 per cartridge, and the project's life would be 3 years. Current assets would increase by $5,000 and payables by $3,000. At the end of 3 years, the equipment could be sold for $10,000.
- What is the required investment, that is, the Year 0 project cash flow?
- What are the project's annual net cash flows?
- What is the terminal year project cash flow?
You did a scenario analysis to better understand the project’s
|
|
Probability |
Unit Sales |
VC% |
NPV |
|
Best case |
25% |
4,800 |
60% |
39,434 |
|
Base case |
50% |
4,000 |
70% |
4,245 |
|
Worst case |
25% |
3,200 |
75% |
-25,080 |
The firm's project CVs generally range from 1.0 to 1.5. A 3% risk premium is added to the WACC if the initial CV exceeds 1.5, and the WACC is reduced by 0.5% if the CV is 0.75 or less. Then a revised NPV is calculated. What WACC should be used for this project?
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