Should the proposed project be undertaken

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Reference no: EM133344278

Case Study: Quaker Ltd. produces breakfast cereal but is considering expanding into the packaged salad business. Thisexpansion will require an initial investment in new equipment of CAD 2,500,000. The new equipment will be placed in a class with a CCA rate of 20%. At the end of the project, the equipment is estimated to have asalvage value of CAD 350,000.

Sales from the new venture are forecasted at CAD 2,900,000 per year for the first six years and CAD 3,500,000 per year for years 7 through 12.

Variable operating costs for the new venture are estimated at CAD 1,900,000 for the first six years, and CAD 2,100,000 for years 7 through 12. Fixed costs will be CAD 800,000 per year for the entire 12-year period which includes rent for the new production facility. NWC will average 30.0% of sales throughout the life of theproject.

A CAD 850,000 overhaul of the new equipment will be undertaken at the end of year 6. Under the IncomeTax Act, this expenditure is capitalized in the same pool as the original equipment. The half-year ruleapplies to this expenditure.

It is assumed that at the end of year 12, the equipment will be sold for its estimated salvage value and the overhaul will not affect this estimate. The firm's marginal tax rate is 30%. The acquisition of the newequipment and any subsequent betterment are subject to an ITC of 5%.

Its RRR is 5.0%, which is used in all NPV analysis. Company policy is to add 3.0% to this discount rate toallow for the extra risk resulting from a new project.

All estimates are expressed in today's dollars and inflation is estimated to be 2.5% per year for the durationof the project.

Question: Should the proposed project be undertaken? Use the real NPV approach.

Reference no: EM133344278

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