Reference no: EM132660670
Webmasters.com has developed a powerful new server that would be used for corporations' Internet activities. It would cost $10 million to buy the equipment in 2020 that is necessary to manufacture the server in 2021; another $10,000 in shipping charges would be required; and it would cost an additional $30,000 to install the equipment.
Webmasters.com decided to finance the new project by bank loan. Interest payments are made annually at an annual rate of 5% with equal end-of-year payments over 7 years.
The equipment would be installed in a building owned by the firm and located in Los Angeles. This building, which is vacant now, and the land can be rented for $20,000 annually before taxes. The project would require net working capital at the beginning of each year equal to 10% of sales.
The servers would sell for $25,000 per unit, and Webmasters believes that variable costs would amount to $10,000 per unit. After 2022, the sales price and variable costs would increase at the inflation rate of 3%. The forecasted fixed costs associated with the new project include 12 workers to manufacture the server earning an average of $30,000 each in salaries and benefits. The workers' salaries and benefits are expected to grow at an average rate of inflation of 3%. Theserver project would have a life of 7 years. If the project is undertaken, it must be continued for the entire 7 years. Also, the project's returns are expected to be highly correlated with returns on the firm's other assets. The firm believes it could sell 3,000 units per year.
The equipment would be depreciated over a 9-year period, using MACRS rates. The estimated market value of the equipment at the end of the project's 7-year life is $500,000. Webmasters' federal-plus-state tax rate is 30%. Its cost of capital is 10% for average risk projects. Low risk projects are evaluated with a WACC of 7%, and high risk projects at 13%.
Using Excel spreadsheet to solve the following question:
Calculate the initial investment, annual after-tax cash flows, and the terminal cash flow of each investment project.