Hydro Electric Cars, Inc. (“HEC”) designs, manufactures, and markets a mid-size automobile designed to be powered by electricity produced by water power. The company is evaluating the expansion of its production plant to enable it to expand its sales capacity for the next 5 years. Last year, the company spent $495,000 to do marketing research analysis to estimate market demand for new markets. The company also spent last year $274,500 for an engineering analysis for the proposed expansion. The current expansion scenario would have total construction costs of $18.4 million and it would take about 120 days to complete (i.e., essentially up-front). TEC would also put in $4.26 million of new production machinery and equipment. Inventory (raw materials, work-in-process, finished goods) investment needed for the expansion to get started would be $16.33 million. Except for the inventory investment, the total upfront investment can be depreciated using the straight-line method over four (4) years. The company expects to incur $3.2 million in incremental annual interest expense, and the company expects it could increase annual dividends by $0.05 per share (there are 10 million shares outstanding). Incremental sales for this project are based on forecast demand of 510 units in the first year; 560 units in the second year; 589 units in the third year; 612 units in the fourth year; and, 602 units in the fifth year. Average sales price per unit is expected to be $55,000 in Year 1; $57,000 in Year 2; $59,000 in Year 4; $61,000 in Year 4; and $63,000 in Year 5. Cost of goods sold is estimated to be 63% of total sales each year, and incremental fixed costs are estimated to be $1.15 million per year. At the end of the project’s estimated life, the company estimates it could sell the purchased machinery and equipment for $3.7 million and the expected the book value for these items would be zero. Also at the end of the project, $2.5 million of inventory could be liquidated at its original cost (with no income tax effect). The company’s income tax rate is expected to be 35% for ordinary income and 21% for capital gains income. If HEC does this project, it will immediately sell some existing surplus equipment for a price of $3.535 million which has a current book value of $1.980 million and which has future depreciation of $495,000 for the next four years. HEC’s weighted average cost of capital is 9.50%, and TEC it believes this project should earn at least a 12.50% average annual return. Put the solutions to the following questions in an Excel spreadsheet with appropriate detail, and use whole dollars in the spreadsheet.

1. What is the upfront total after-tax cash costs for this proposed project?

2. What are the Total Annual Free Cash Flows for Year 1? Year 2? Year 3?

3. What is the Total After-Tax Operating Cash Flow for Year 5 (exclude Terminal Year-specific items)?

4. What is Terminal Year-specific Cash Flow (i.e., After-Tax Salvage Value excluding the Annual Operating Cash Flow portion)? Show your work in appropriate detail.

5. Is(Are) there any irrelevant cash flow(s) mentioned in this problem? If so, what is(are) it(they)?

6. Are there any sunk costs for this project? If so, what are they?

7. Are there any opportunity costs for this project? If so, what are they?

8. What is the Net Present Value for this project proposal?

9. What is the Internal Rate of Return for this project proposal?

10. Would this project be a good investment? Why? (Calculate at least two capital budgeting evaluation methods but use only one to decide if the proposed project is a good investment)