Your firm has the opportunity to enter into a new market. The new opportunity is expected to generate revenues of $2.5 million the first year with sales expected to grow by 7% per year for four years. The entire project lasts five years and requires an initial investment in fixed assets of $2.75 million. The project also requires an initial investment of $85,000 in net working capital which will be recovered at the end of the project. Based on your research, variable costs account for 68% of revenues and fixed costs are $105,000 each year. The fixed asset classifies as a 7-year asset and will be depreciated using MACRS. Your marginal tax rate is 35%, your required rate of return is 18%, and you need to get paid back your start-up costs within 4 years. You believe you can salvage the asset for $500,000 at the end of the project and you don’t plan to use debt financing.
Year Depreciation Rate
c. What is the cash flow from assets for each year?
d. What is the net present value?
e. What is the IRR?
f. What is the payback period?
g. Based on the answers to d-f above should you accept this project?
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