A company manufactures a variety of household electronic equipment. A year ago, they conducted a marketing study to poll consumers’ opinion about new home security systems. The study cost them $1,500,000. Today, the company is considering introducing a state-of-the art home security system. The company’s CFO has collected the following information about the proposed product.
The project has an anticipated life of 4 years.
The company has an old machine with 3 years left on its useful life. This machine was being depreciated using straight line method to 0 salvage value. This machine was purchased 3 years ago for $500,000. The market value of this machine is $150,000. The company intends to sell this old machine and buy a new one. This old machine will not have any value four years from now.
The new machine costs $450,000 and requires $150,000 shipping and installation costs. The new machine falls into 5-years MACRS category (20%, 32%, 19.2%, 11.52%, 11.52% and 5.76%).
The production of the equipment will require inventories to increase by $450,000 at time 0; in addition, accounts payable will increase by $150,000.
The new equipment is expected to generate sales revenue of $500,000 the first year. The revenue is expected to increase by $100,000 every year. Each year the operating costs (excluding depreciation) are expected to equal 25 percent of sales revenue.
The company’s interest expense each year will be $350,000.
The new equipment is expected to reduce the after-tax cash flows of the company’s existing products by $150,000 a year.
The company can sell this new machine at the end of 4 years for $250,000 in the market. The company’s overall cost of capital is 10 percent. The company’s tax rate is 35 percent.
What is the initial investment CF0?
What is the CF1 (The cash flow to be used in NPV calculation)? What is the CF4 (The cash flow to be used in NPV calculation)? What is the NPV of the project?