Reference no: EM131521172
Terrapin Texts (formerly Buckeye Books) is considering opening a new production facility in College Park. The firm uses free cash flow discounted by the cost of capital. The firm has the following information:
The up front cost of the facility at t=0 is $10 million. The facility will be depreciated on a straight line basis to 0 over 5 years
The company will operate the facility for 5 years. It can be sold for $3 million at t=5.
Interest expense will increase by $50,000/year with this project
The firm spent $750,000 on a feasibility study a year and a half ago. The study concluded that opening a new facility would be profitable.
If the facility is opened Terrapin will need additional inventory at t=0 of $2 million. Accounts payable will increase by $1 million at t=0. All working capital will be recovered at t=5.
If the facility is opened it will increase sales by $7 million/year in year 1 and costs will increase by $3 million/year.
Inflation is expected to be 4%/year for the life of the project.
Inflation will not impact year 1 revenues and costs, but will impact revenues and costs in years 2-5.
The tax rate is 40%.
If the project is not done, the land on which the facility would be built will be sold for $5 million immediately.