Incremental Cash Flows and Project Evaluation

Classic Cars is considering expanding its product line by manufacturing classic Mustangs. The necessary equipment will cost $4,000,000 and installation costs will be $50,000. The equipment will be depreciated using a 5 year MACRS life with depreciation rates of 20%, 32%, 19.2%, 11.52% and 11.52%in Years 1-5, respectively. Projected sales in units will be 300/year for each of the next 5 years. The sales price is projected at $27,000 per car and variable costs at $18,000 per car. Fixed costs of the firm will increase by $1,200,000 per year. The company would anticipate selling the equipment for $500,000at the end of year five. To support the new operation, the company anticipates having to increase its net working capital by $600,000 at the beginning of the project, but will no longer need to maintain the higher level of working capital once it sells the equipment. If the company’s tax rate on ordinary income is 35%, its tax rate on capital gains is 15%, and its WACC is 12%, should the company do the project?