Reference no: EM132594079

Grant Thomas, the financial advisor to Innovative Manufacturing is evaluating the following new investment in a manufacturing project:-

• The project has a useful life of 10 years.
• Land costs $5m and is estimated to have a resale value of $7m at the completion of the project.
• Buildings cost $4m, with allowable depreciation of 5% pa straight-line and a salvage value of $0.8m.
• Equipment costs $3m, with allowable depreciation of 20% pa straight-line and a salvage value of $0.4m. An investment allowance of 20% of the equipment cost is available.
• Revenues are expected to be $5m in year one and rise at 10% pa.
• Cash expenses are estimated at $2m in year one and rise at 5% pa.
• The new product will be charged $300,000 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 $200,000 has been spent on a feasibility study for the new project.
• The project is to be partially financed with a loan of $6m to be repaid annually with equal instalments at a rate of 5% 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 10% pa.

Required

Question (a) Calculate the NPV. Is the project acceptable? Why or why not?

Question (b) Conduct a sensitivity analysis showing how sensitive the project is to revenues, cash expenses and to the cost of capital. Explain your results.