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The equipment for the second production line will cost $3 million to purchase and install and will have an estimated after-tax scrap value of $200,000. Furthermore, at the end of five years, the production line will have to be refurbished at an estimated cost of $2 million. RWE's management estimates that the new production line will add $700,000 per year in after tax cash flows to the firm.
Required:
i. If RWE uses a 10% discount factor to evaluate investments of this type, what is the net present value of the project? What does this NPV indicate about the potential value RWE might create by purchasing the new production line?
ii. Calculate the internal rate of return and profitability index for the proposed investment. What do these two measures tell you about the project's viability?
iii. Calculate the payback and discounted payback periods for the proposed investment. Interpret your findings.
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