Question

You must analyze a potential new product-a caulking compound that Cory Materials' R&D people developed for use in the residential construction industry. Cory's marketing manager thinks they can sell 115,000 tubes per year at a price of $3.25 each for 3 years, after which the product will be obsolete. The required equipment would cost $150,000, plus another $25,000 for shipping and installation. Current assets (receivables and inventories) would increase by $35,000, while current liabilities (accounts payable and accruals) would rise by $15,000. Variable cost per unit is $1.95, fixed costs be $70,000 per year, and fixed assets would be depreciated under MACRS with a 3-year life. [33%, 45%, 15%, 7%), when production ceases after 3 years, the equipment should have a maket value of $15,000. Cory's tax rate is 40%, and it uses a 10% WACC for average-risk projects g. If the risk of the project under consideration is greater than the risk of the company as a whole, would you expect the NPV to be: higher, lower, unchanged when compared to a project of average risk? circle the correct answer.] h. If Cory's management accepts a project that is riskier than the company as a whole, will Cory's cost of capital rise, fall, remain unchanged? circle the correct answer.]

Answer 1

g. NPV will be lower because (after taking assumption that project average risk will be lower than current project risk) a high discount rate means that NPV is affected with less cash flow occur further in the future results to lesser present cashflows leads to lesser NPV.

h. If Corys management accepts a project which is riskier than company as a whole then overall cost of capital will remains unchanged since cost of capital is not directly related to cashflow of the business. Irrespective of risk percentage COC will remains same.( It is not impacting real cashflows and while calculating cost of capitali we are not considering final earnings in total, we are only taking interest component and dividend cost while calculating COC which is not directly related to individual projects)