As the director of a firm’s finance department, you have been asked to evaluate a project. After collecting information from various sources, you have determined the following:
– Total research (information gathering for project analysis) expenses to date are $260,000.
– The project requires an initial investment of $24 million to build a new plant and purchase equipment. The investment will be depreciated as a MACRS 7-year class asset.
– The new plant will be built on some of the company’s land which has a current, after-tax market value of $4.3 million.
– The company will produce units at a cost of $130 each and will sell them for $420 each. There are annual fixed costs of $500,000.
– Unit sales are expected to be 150,000 each year for the next 6 years, at which time the project will be abandoned.
– If the project is accepted, the firm will need to hire an additional manager with an annual salary of $80,000.
– At the end of the project, the plant and equipment is expected to be worth $8 million (before tax) and the land is expected to be worth $5.4 million (after tax).
– To supplement the production process, the company will need to purchase $1 million worth of inventory. That inventory will be depleted during the final year of the project.
– The company’s marginal tax rate is 40% and its discount rate is 12%.
Should the project be accepted?