Burgan Brothers is considering a project where they would expand their Adelaide based business by opening a new facility in the Gold Coast. The company's CFO has assembled the following information regarding the proposed project:
To purchase the equipment required to undertake the project it will cost $2,450,000 today (at t = 0), and there will be a 15% cost to assemble the plant in a building that could otherwise be sold for $450,000. The have also spend $250,000 engaging business advisory consultants to undertake market entry strategy work re entering this market.
The cost of the facility will be depreciated on a straight-line basis over six years (Australian Tax Office ruling). The CFO has estimated that the project will generate revenues starting at $8.5 million, but declining at 15% over the next four years:
Operating costs excluding depreciation but including a property lease are expected to equal 60 percent of revenue. If the company opens the facility, it will need to increase its working capital by $200,000 at t = 0.
The company expects to have a first mover advantage in this market for only around four years, and expects to retire the project at that time (although should it prove that it has maintained some its competitive edge at that point. At this time, the project equipment estimated salvage value is expected to be $1,325,000, and it will pay a 10% commission to the agent who handles the decommissioning of the project. The company will also recover the working capital investment that it made at t = 0.
The project will be evaluated using the WACC calculated in Question 2 above.(WACC= 12.93% )
The company's tax rate is 30 percent.
Provide advice as to whether the company should proceed with the project.