Reference no: EM13722052

Reality Automotive Corp. (“RAC”) manufactures after-market parts for automobiles and trucks (seat belts, windshield wiper blades, floor mats, and truckbed mats). The company is evaluating the expansion of its manufacturing plant to enable it to take on a new customer segment for the next 5 years. Last year, the company spent $123,000 to do marketing research analysis to estimate market demand for new customer segments. The current expansion scenario would have total construction costs of $1.25 million and it would take about 60 days to complete (i.e., essentially up-front). RAC would also put in $575 thousand of new machinery and equipment. Inventory (raw materials, work-in-process, finished goods) investment needed for the expansion to get started would be $200 thousand. Except for the inventory investment, the total upfront investment can be depreciated using the straight-line method over four years. The company expects to incur $165 thousand in incremental annual interest expense, and the company expects it could increase annual dividends $0.10 per share (there are 1,700,000 shares outstanding). Incremental sales for this project are based on forecast demand of 9,000 units in the first year, 11,500 units in the second year, 12,600 units in the third year, 13,400 units in the fourth year, and 7,000 units in the fifth year, with an average selling price of $200 per unit. Cost of goods sold is estimated to be 65% of total sales each year, and incremental fixed costs are estimated to be $150,000 per year. At the end of the project’s estimated life, the company estimates it could sell the purchased machinery and equipment for $100,000 and the expected the book value for these items would be zero. Also at the end of the project, $150,000 of inventory could be liquidated at its original cost (with no income tax effect). The company’s income tax rate is expected to be 36% for ordinary income and 21% for capital gains income. If RAC does this project, it will immediately sell some existing surplus equipment for a price of $475,000 which has a current book value of $330,000 and which has future depreciation of $110,000 for the next three years. RAC’s weighted average cost of capital is 12%, so it believes this project should earn at least a 14% average annual return.

What is the upfront total after-tax cash cost for this proposed project?