Reference no: EM133239403

Your team has just been hired by a company to advise the firm's capital budgeting division. The company has raised a sum of money, which they will invest in a new project. From your team of financial specialists, they are seeking advice on the financial feasibility of one of the proposed projects.

Over the last two years, the company has already spent $100,000 on R&D for the newly proposed project. If the company would decide to actually go ahead with the project, the initial investment in the required equipment is expected to be $1,030,000. The new project is expected to run for 10 years, and after that point the project will be retired. The expectation is that at the end of the project, the assets of the project can be sold at a residual value of only 3% of their original value. Half of the total sum which the company has raised for this project has been borrowed at an interest rate equal to the average cost of debt of the company of 4.4%.

In the first year the project is expected to generate a revenue of $618,000, and in the following years the revenues of this new project are expected to grow by 8.3% each year. Your team will have to determine the rest of the cash flows associated with this proposed project. The CFO of the company has indicated that it would be reasonable to expect that the operating costs of the new plant will be of similar proportion relative to the revenues as the company's other projects, which is at 65%. The new project would require an additional NWC of $20,600. Depreciation of the new equipment should be done in a straight-line over the full life of the project to a value of 0. The cost of capital of the company is 11.44%, and the effective tax rate for the company is 13%.

The company is asking your team for financial advice. The results of your analyses will have to be presented to the company's executive management team.

1. A brief discussion of the newly proposed project. Which product/service is being developed? (The product that is being developed is a new phone)

2. A demonstration of the expected yearly cash flows of the project. Remember, members of the senior management team often do not have a finance background, so you will have to present clear tables which show the calculation of the free cash flows, and clearly explain how the free cash flows were computed. You basically have to explain to them in your presentation how capital budgeting works.