Reference no: EM132626928

RedBull Racing Enterprises Telemetry Department is looking at a new Telemetry project with the initial pilot project expected to be for five years. You have been briefed by the previous CFO, that the company's expected marginal tax rate is 30% over the life of the project and tax is paid at the end of the year in which the cash flows occur. Tax depreciation is straight line over 4 years. Expected inflation rate over the next five years is 7% and the company's cost of capital is 12%. It is further assumed that there will be a growth of 2.5% after the initial pilot project is implemented. It was also communicated that Working Capital requirements are 10% of Gross Profit and is assumed to be needed at the start of the year.

A new datacenter which consists of servers and networking equipment will be built on a new property. The property will be a non-depreciable capital requirement with estimated cost of $400,000 and is expected to maintain its value in real terms (i.e. to increase in value with inflation). The servers and networking equipment for the datacenter is needed immediately if the project is given approval to proceed. The cost for this new datacenter is estimated to be $850,000 including freight and installation for the servers and networking equipment. Salvage value is expected to be $75,000 at the end of Year 5. The company plans to borrow the $850,000 for the hardware platform from Westpac Bank at an interest rate of 8% per annum. It will use retained earnings to fund the purchase of the property, although to afford this, it will reduce its dividend payments by $70,000 per year for the five years.

The RedBull Telemetry Department employs 5 engineers at a cost of $50,000 per engineer per year. It is estimated that this new project will make use of one engineer to design the Telemetry system in the first year on a full time bases and only half of his time will be required for the remainder of the project.

To promote the new product to new potential customers, the company will spend $80,000 on direct marketing in the second year of the pilot project.

Real gains are subject to capital gains tax at the marginal rate. Gross Profit (assume at end of year) from operations for Year 1 is estimated at $350,000 and will grow by 10% for Year 2 and Year 3 respectively. From Year 4 it is expected that the Gross Profit will decrease by 20% until completion of the pilot project.

Make a recommendation and motivate if the company should undertake this project.