Reference no: EM132957816
Question - As the financial advisor to Lockdown Manufacturing you are evaluating the following new investment in a manufacturing project:-
The project has a useful life of 10 years.
Land costs $12m and is estimated to have a resale value of $16m at the completion of the project.
Buildings cost $6m, with allowable depreciation of 6% pa reducing balance and a salvage value of $2m.
Equipment costs $5m, with allowable depreciation of 30% pa reducing balance and a salvage value of $1m. An investment allowance of 15% of the equipment cost is available.
Working capital of $2m is required at the start of the project but is anticipated to be recovered at the end of the project's life.
Revenues are expected to be $10m for the first 5 years and $8m for the next 5 years.
Cash expenses are estimated at $5m in year one and rise at 5% pa.
The new product will be charged $500,000 of allocated head office administration costs each year even though head office will not actually incur any extra costs to manage the project.
An amount of $150,000 has been spent on a feasibility study for the new project.
The project is to be partially financed with a loan of $15m to be repaid annually with equal instalments at a rate of 4% pa over 10 years.
Except for initial outlays, assume cash flows occur at the end of each year.
The tax rate is 30% and is payable in the year in which profit is earned.
The after tax required return for the project is 12% pa.
Required -
(a) Calculate the NPV. Is the project acceptable? Why or why not?
(b) Conduct a sensitivity analysis showing how sensitive the project is to revenues, the resale value of the land and to the required rate of return. Explain your results.
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