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ProBuilder Company is thinking of introduction of new product line that will need construction of new plant and equipment, estimated to cost $8,000,000 plus $600,000 for shipping and installation. Depreciation will be straight line method to zero over 10 years. ProBuilder obtained land on which the plant is to be built year ago for $500,000, but land prices have risen 15% since then. On termination of project, it is expected that land could be sold for $1,100,000.

If project goes ahead extra working capital equal to 40% of annual sales revenue will be needed. Suppose the initial working capital is required immediately (T0), and that any subsequent changes also haapen at starting of each period. Sales revenues are evaluated to be $1,000,000 in Year 1, $2,000,000 in Year 2, and $5,000,000 in Years 3 - 10.

Corresponding cash operating are $800,000, $1,250,000 and $2,000,000. ProBuilder expects fixed costs to be $75,000 per year.

i. If tax rate is 30%, and cost of capital is 14.5%, must new product be introduced?

ii. If inflation is expected to average 5% over next 10 years, does it seem that project's cash flow estimates are real or nominal? Is 14.5% cost of capital real or nominal rate? Is current NPV biased, and if so, in which direction?

Project Management, Management Studies

  • Category:- Project Management
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