Question

S & P Corporation (SPC) is considering entering a new line of business. In alaiyzing business, the financial staff has accumulated the following information: pu The new business will require a capital expenditure of $7 million at t = 0. This expenditure will be used to purchase new equipment. This equipment will be depreciated according to MACRS five-year class (see table on next page). · The equipment will have a salvage value of $500,000 after five years. The required level of working capital is 75% of expected sales over the year: · wa : 7.5% *Sales+1 new business is expected to have an economic life of five years. . The . The Marketing Department forecasts to sell 300,000 units during the first year and then 400,000 units thereafter. The expected price is $10 per unit during the first year. Price must be adjusted by inflation in subsequent years. Variable cost is expected to be $5.00 per unit whereas fixed cost is $100,000. These figures must be adjusted by inflation in subsequent years. The new product is expected to increase before-tax cash flows of the company's existing products by $300,000 per year in real terms. This amount also has to be adjusted by inflation. The expected inflation rate during the life of the project is 2% per year The company's interest expense each year will be $220,000. . The company's tax rate is 26%. The company is very profitable, so any accounting losses on this project can be used to re the company's overall tax burden. The company's cost of capital (WACC) is 8.71%. However, the proposed project is riskier than the average project for SPC and therefore you have to add 2% to the corporate cost of capital. · The company's CFO wants you to analvze the project and to write a short report with your recommendation. Please be advised that both financial and non-financial managers wi therefore, make sure you explain your calculations and recommendation. ll read the report; MACRS 5-year class Depreciation Year 0.20 0.32 0.19 0.12 0.11 0.06 5

Answer 1

please find the answer in the picture.

Calculation for cash flow 300000 400000 400000 400000 400000 3000000 4080000 4160000 4244000 4328000 150000 2040000 2080000 2120000 2164000 100000 102000 104040 106121 108243 220000 220000 220000 220000 220000 1400000 2240000 1330000 840000 770000 300000 306000 312120 318362 324730 80000-216000738080 1276242 1390486 191901 331823 1028960 9200 -216000 546179 944419 1028960 1400000 2240000 1330000 840000 770000 57200 1459200 2024000 1876179 1784419 1858160 0.9030.816 0.737 0.666 0.601 quantity Sale qty 10 with inflation Variable cost with subsequent inflation Fixed cost with subsequent inflation Interest Depreciation as per table Increase in cash flow for exist product EBT Tax( 26%) EAT Depreciation as per table scrap value cash inflow PV @ 10.71 PV of cashflovw less less less less add add 1318038 1651584 1382744 1188423 1116754 6657543 Scrap Value Book Value Gain Tax Net Gain calculation for cash outflow Initial Investment WC (705% sale for the (next year) change seen in WC 225000 306000 312000 318300 324600 0 6300 324600 8100060006 300

7000000 Initial Investment WC (705% salefor the (next year) change seen in WO Total Investment PV 10.71 225000 306000 312000 318300 324600 81000 6000 6300 6300-324600 7225000 81000 600063006300324600 1 0.90326 0.816 0.737 0.666 0.601 pv for total investment 7225000 73164.14614195.8 -195085 7116814 6657543-7116814 -459271 due to negative npv project wont be approved