International Foods Corporation (IFC) currently processes seafood with a unit it purchased several years ago. The unit, which originally cost $500,000, currently has a book value of $250,000. IFC is considering replacing the existing unit with a newer, more efficient one. The new unit will cost $700,000 and will require an additional $50,000 for delivery and installation. The new unit will also require IFC to increase it’s investment in initial net working capital by $40,000. The new unit will be depreciated on a straight-line basis over five years to a zero balance. IFC expects to sell the existing unit for $275,000. IFC’s marginal tax rate is 40%.
If IFC purchases the new unit, annual revenues are expected to increase by $100,000 (due to increased processing capacity), and annual operating costs (exclusive of depreciation) are expected to decrease by $20,000. Annual revenues and operating costs are expected to remain constant at this new level over the 5-year life of the project. IFC estimates that its net working capital investment, will increase by $10,000 per year over the life of the project. At the end of the project’s life (5 years), all working capital investments will be recovered. After five years, the new unit will be completely depreciated and is expected to be sold for $70,000. (Assume that the existing unit is being depreciated at a rate of $50,000 per year).
a. Calculate the project’s net investment.
b. Calculate the annual net cash flows for the project.