Derive the projects free cash flows to the firm

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Reference no: EM132068263

To produce this material, an investment of $4 million in plant and equipment is required. The firm estimates the investment will have a five--year life, using straight-line depreciation toward a zero salvage value.

However, the investment has an anticipated market salvage value at the end of the project's life equal to 10% of its original cost.

The projected sales volume during the project's life is as follows (in millions of pounds): 1, 1.5, 3, 3.5, and 2.

To operate the new plant, BASF estimates that it will incur additional fixed operating expenses of $1 million per year and variable operating expenses equal to 45% of revenues.

Furthermore, BASF estimates that it will need to invest 10% of the anticipated increase in revenues each year in net working capital.

The price per pound of the new carbon material is expected to be $2 in years 1 and 2, then $2.50 in years 3 through 5. BASF's marginal tax rate is 38%. The company requires a minimum return of 15% in projects of similar risk.

a) Derive the project's free cash flows to the firm for each year of the proposed investment (including the initial investment outlay).

b) Using the NPV investment decision, does this project create value.

Reference no: EM132068263

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