Question: Capital Budgeting Problem. ABC Corporation is evaluating a new product. As assistant to the director of capital budgeting, and you must evaluate the project. The project would be produced in an unused building adjacent to ABC's Sandusky plant; ABC owns this building which has an historical cost of $325,000 as well as accumulated depreciation of $325,000. Additionally, you learn that ABC renovated the building last year at a price of $125,000, expensing the cost. Required equipment for the project would cost $235,000, plus an additional $25,000 shipping and installation. Net working capital will amount to 8% of sales in the following year. The machinery is considered 5-year property for tax purposes--be sure to use MACRS.
The project is expected to operate for 5 years, at which time it will be terminated. The cash inflows are assumed to begin one year after the project is undertaken, or at t=1 and to continue out to t=5. At the end of the project's life (t=5) the equipment is expected to have a salvage value of $75,000. Unit sales are expected to total 139,000 units in the first year, 124,000 in the 2nd, 143,000 in the third and 125,000 and 95,000 in the final years. The expected sales price is $1.39 per unit. Cash operating costs for the project (i.e., excluding depreciation) are expected to total 61 percent of dollar sales. Overhead expenses to be allocated to the project are 1% of sales. ABC's marginal tax rate is 29% and its required rate of return is 10%. Tentatively, the project is expected to be of equal risk to the corporation's other projects. You have been asked to prepare a spreadsheet analysis and to calculate NPV, IRR, profitability index, and payback period.