Reference no: EM132953845

Question: Haystack Bookstore is considering selling a new line of children's books by a very famous author.

They expect selling the books will increase annual revenues by $2,000,000 per year and grow at 1% for the next 5 years (i.e. year 1 revenues are expected to be $2M, growing at 1% until year 6, which is the last year they would sell the books). Cash operating costs (not including depreciation or allocated overhead) for the new line of books are expected to be $600,000 in the first year and grow at a rate of 2% for the next 5 years (i.e. until year 6). After year 6, the new books will be discontinued.

The new line of books will (per the contract with the author) require extremely elaborate shelving that will last for all six years and cost $5,000,000, due upon signing the contract. The shelving will be depreciated for tax purposes on a straight-line basis to a remaining book value of $0 over 6 years. Management anticipates that it will be able to sell this shelving for scrap metal for $300,000 at the end of 6 years. Assume any gain or loss on the sale of the shelving is taxable (or tax-deductible) at the firm's tax rate of 35%.

To help cover costs of the existing business, Haystack will allocate $1,000,000 per year in overhead to the new line of books when evaluating the line's profitability. By beginning to sell the books, the bookstore will decide to remain open for longer hours, which will increase total overhead by $100,000 per year for each of the 6 years (they would not extend open hours if they did not sell these books).

The cost of capital (appropriate discount rate) for the project is 11.4%.

Should Haystack Bookstore decide to sell the new books? Why or why not? Support your answer.