Management

A manufacturing company is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 45% of sales. Indirect incremental costs are estimated at $95,000 a year. The project requires a new plant that will cost a total of $1,500,000, which will be a depreciated straight line over the next 5 years. The new line will also require an additional net investment in inventory and receivables in the amount of $200,000.

Assume there is no need for additional investment in building the land for the project. The firm’s marginal tax rate is 35%, and its cost of capital is 10%.

  • Prepare a statement showing the incremental cash flows for this project over an 8-year period.
  • Calculate the payback period (P/B) and the net present value (NPV) for the project.
  • Answer the following questions based on your P/B and NPV calculations:
    • Do you think the project should be accepted? Why?
      • Assume the company has a P/B (payback) policy of not accepting projects with life of over 3 years.
      • If the project required additional investment in land and building, how would this affect your decision? Explain

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