Ocean Tide Industries is planning to introduce a new product with a projected life of eight years. The project is in the government’s preferred industry list and qualifies for a one-time subsidy of $2,000,000 at the start of the project. Initial equipment (IE) will cost $14,000,000 and a piece of additional equipment (AE) costing $1,000,000 will be needed at the end of year 2. At the end of 8 years, the original equipment, IE, will have no resale value but the supplementary equipment, AE, can be sold for its book value of $100,000. Working capital of $1,500,000 will be needed.
The sales volume over the eight-year period have been forecast as follows:
Year 1 80,000 units
Year 2 120,000 units
Years 3-5 300,000 units
Years 6-8 200,000 units
A sale price of $100 per unit is expected and the variable expenses will amount to 40% of sales revenue. Fixed cash operating expenses will amount to $1,600,000 per year.
Additionally, an extensive advertising campaign will be launched, which will need annual expenses as follows:
Year 1 $3,000,000
Year 2 $1,500,000
Years 3-5 $1,000,000
Years 6-8 $400,000
The company falls in the 50% tax category and believes 12% to be an appropriate estimate for its after-tax cost of capital for a project of this nature. All equipment is depreciated on a straight-line basis. In the event of a negative taxable income, the tax is computed as usual and is reported as a negative number, indicating a reduction in loss after tax.
You are required to:
- Compute the initial cash flow for the project
- Compute the earnings before taxes for years 1 through 8
- Compute the earnings after taxes for years 1 through 8
- Compute the OCF for years 1 through 8
- Compute the Terminal cash flow
- Compute the FCF for years 1 through 8
- Compute the NPV and IRR
- Should the project be accepted?