A well known university in Maryland works on a new LMS system, The management anticipates that new system will have the first year revenues of $400,000 with subsequent annual growth of 5%. Operating costs are 30% of revenues.
The project requires investment in new equipment, which will have a five year anticipated life and will be depreciated using MACRS depreciation method toward a zero book value (MACRS depreciation rates are given below). However, the company will be able to sell the equipment on the after-market at the end of year 5 for 20% of its original cost. The company requires a 10% rate of return from its investment and faces a 38% tax rate (overall the company is profitable). In addition to capital investment, the project requires an outlay of net working capital equal to 10% of revenues in the coming year. I.e., at time 0 (beginning of year 1) net working capital requirement is $25,000 and will grow in subsequent years. All NWC will be recovered after the project's end.
a) Calculate the NPV and IRR for the project. Should the company undertake the project? (see chapter 2 for details)
b) The manager raised some concerns about costs, first year revenues and revenue growth projections. Considering one factor at a time, at what level of operating costs, initial revenues, and revenues growth the project will break-even (NPV=0)? (see chapter 3 for details)
c) Looking at percentage difference between the predicted level and critical (break-even) level of each of the three factors, which of them is the most critical? (see chapter 3 for details)