Bender Guitar Corporation, a manufacturer of custom electric guitars, is contemplating a $1,000,000 investment in a new production facility. The economic life of the facility is estimated to be five years, after which the facility will be obsolete and have no salvage value.
To make the new facility operational, building improvements costing $400,000 will be required. In addition, a $50,000 increase in working capital will be needed.
Bender's accounting and marketing departments have provided the following information: the firm will use the straight-line method of depreciation; the Company is in the 30% tax bracket; the weighted average cost of capital is 8%.
Here are Earnings before Interest and Taxes (EBIT) estimates for the new facility:
Year 1.........$80,000
Year 2.......$100,000
Year 3.......$120,000
Year 4........$140,000
Year 5.......$165,000
1. Diagram the cash flows for the project using a time line. For each of Years 1 through 5, include the following data on your diagram (in this order) : EBIT, tax, depreciation, Operating Cash Flow (OCF), and discounted OCF.