Question: ENX Corp. is evaluating an investment proposal to open a new production facility. Market research completed last year indicated that the firm can expect an increase in annual revenues from the new production of $3,500,000.00. The cost of the market research was $250,000.
The estimated immediate upfront costs of the constructing of the new facility is $7,500,000.00. For tax purposes this facility will be part of a CCA asset class that depreciates assets at a rate of 30% per year. If the facility is opened, ENX will have to increase inventory immediately by $1,000,000.00. In addition, its accounts payables will increase immediately by $500,000.00. There are no other expected changes in net working capital until the end of the project at which time net working capital will return to its previous level.
The operating costs of the facility are expected to be $610,000.00 per year. The company plans to operate the facility for 4 years and estimates that the facility salvage value will be $1,250,000.00.
The company tax rate is 50%. The cost capital for ENX is 7.44%.
Calculate NPV of the investment proposal and provide a recommendation as to acceptance of rejection of proposal.
Explain why the NPV decision rule is preferred over other methods such as IRR rule and the payback rule. In your answer be sure to define IRR rule and the payback rule.
Explain the preferred method of selecting between multiple projects when a firm faces resource constraints.