Question

The POM Corporation, a firm in the 28% marginal tax bracket, with a 16% required rate of return or discount rate, is considering a new project. This project involves the introduction of a new product. This product is expected to last 5 years and then, because it is somewhat of a fad product, it will be terminated.

Cost of new plant and equipment:      $195,000,000

Shipping and installation costs:                5,000,000

Unit sales:

Year                Units Sold

                                       1                   2,000,000

                                       2                   2,000,000

                                       3                   2,000,000

                                       4                   1,000,000

                                       5                   1,000,000

Sales price per unit: $800/unit in years 1-3; $600/unit in years 4 and 5

Variable cost per unit: $400/unit

Annual fixed costs: $10,000,000

There will be an initial working capital requirement of $3,000,000 just to

get production started.

At the conclusion of the project, the plant and equipment can be sold for

$15,000,000.   

The plant and equipment will be depreciated over five years on a straight-

line basis to a zero-salvage value.

Required:

1. Determine the net present value of the project.
2. Determine the payback period of the project.
3. Determine the internal rate of return of the project.
4. Do you recommend that the project be undertaken? Explain

Answer 1