Reference no: EM131983873

Howell Petroleum is considering a new project that complements its existing business. The machine required for the project costs $4.8 million. Set up and training associated with the project will be an additional 10 percent of the project costs and will be expensed immediately. The marketing department predicts that sales related to the project will be $1.0 million in the first year. Thereafter, marketing research suggests that annual sales in year 2 through 4 will be either $2.5 million or $5.0 million with equal probability. In year 5 and beyond, annual sales will be either $0 or $1 million with equal probability. The EBIT margin for sales in year 5 and beyond is expected to be 45% and the NWC/Sales requirement is expected at 5%. The machine will be depreciated to zero over its four-year economic life using the 3-year MACRS schedule which is 0.3333, 0.4445, 0.1481, 0.0741. The machine will remain in use as long as sales are being generated so there is no salvage value expected. Cost of goods sold are predicted to be 45 percent of sales in year 1 through 4. Fixed operating costs, not associated with the project that will be allocated to the project are $500,000 per year. Fixed operating costs directly associated with the project are expected to be $200,000 per year in years 1 through 4. Howell also needs to add net working capital of $150,000 immediately. In year 2 through 4, net working capital will be 20 percent of sales. The corporate tax rate is 35 percent. The required rate of return for Howell is 14 percent. Should Howell proceed with the project?