New capacity to increase production

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Reference no: EM132007934

Marsh Ltd, is a manufacturer of marshmallows. It is setting up a new capacity to increase production. The sales revenue expected from this new capacity is $500,000 in year 1. In year 2, sales revenue is expected to increase by 20% and in year 3, sales revenue is will fall to 50% of year 2 revenue. Year 3 will be the last year of production as the equipment is expected to fully wear out by then. Operating expenses (excluding depreciation) will be 40% of sales revenue. Marsh will have to incur capital expenditure of $300,000 in year 0 to set up the plant, equipment, etc. Depreciation is $100,000 each year for 3 years. The asset is fully depreciated in year 3 and it has no salvage value. Corporate tax rate is 30%. Marsh plans to borrow $ 100,000 at an interest rate of 10% per annum to finance part of the investment. Net working capital is estimated to be 10% of sales revenue and the investment in net working capital needs to be made in the previous year. For example, $ 50,000 is needed to be invested in net working capital in year 0 so as to be able to achieve the sales of $ 500,000 in year 1. The cost of equity is 20% and the weighted average cost of capital is 17.97%. What is the NPV of the project?

Reference no: EM132007934

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