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Louie's Leisure Products is considering a project which will require the purchase of $1,000,000 in new equipment. The company plans to pay only half of this purchace price at the beginning and the rest will be paid over 5 years ($500,000 will be paid at the purchase tiem in 2020, and each year the company will pay $100,000). The machine will be good for 5 years. Depreciation will be $120,000 per year (year 2021 to year 2025), with $450,000 salvage value at the end of year 2025. This project will require an upfront investment in inventory of $100,000 that will be reclaimed at the end of the project. It will allow the company to process and sell additional products generating $900,000 increase in sale per year. Total added costs will be $400,000 per year, and the tax rate is 35%, which results in a net income pf $317,200 per year. This project will be located in a building currently owned by the company earning the annual rent of $5,000. The managerial team has paid an analyst $700 to forecast the cash flows mentioned above. The required return on this project is 20%.
a. Based on Net Present Value (NPV), is this project worth taking on?
b. The managerial team is looking for ways that allow them to report a higher amount of depreciation in the first two years of the asset's life. What are the possible reasons for this?
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