Cost Profit Analysis in case of new Equipment.
Best Company has the opportunity to expand capacity of current manufacturing equipment with the following expected results.
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Annual Sales Volume in Units
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250,000
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Annual Cash Fixed Costs (ex depreciation)
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$3,800,000
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Selling Price per Unit
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$60
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Variable Cost per Unit
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$29
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Capital expenditures for the purchase of the new equipment will be $10,000,000. Old equipment must be cleared from the site in order to install the new equipment. Proceeds of $80,000 are expected from the removal and sale of the old equipment, which has a book value of $50,000. Cash flows from tax effects are realized at the end of the year when the tax return is filed. As soon as the new equipment is up and running, accounts receivable will increase by $500,000 and will be released at the end of the equipment's useful life. The annual cash fixed costs exclude depreciation charges. There is no salvage value on the new equipment. The company has a 15% cost of capital and the income tax rate is 40%. The equipment will generate cash flows for four years (i.e., the useful life) and the relevant 3-year MACRS depreciation schedule is as follows: 0.333, 0.445, 0.148, and 0.074. Earnings for the overall company are positive.
a) Prepare a cash flow profile that shows the net cash flows for each time period (i.e., time 0, 1, 2, 3, and 4). Calculate the NPV of the project.
b) What is the payback period (be precise)?