Reference no: EM132968847

Problem - The project has a useful life of 10 years. As the financial advisor to Lockdown Manufacturing you are evaluating the following new investment in a manufacturing project:-

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.