Reference no: EM133006960

You are hired to perform a project analysis for your client, a very profitable producer of computer parts. To compensate you for your valuation services, your contract stipulates that the company will pay you a one time - tax deductible! - fee of $70,000 at T=0.

• For the next 7 years, the client would be producing special computer chips. In year 1, the sales will be 90,000 cords. Every year thereafter, the number of cords sold is expected to increase by 4000 per year.
• The price per cord is expected to be $15 the first year; and the price is expected to increase 3% per year thereafter. The variable costs (i.e. the material) are expected to be 20% of the revenues every year. In addition, the client is expected to pay fixed costs of $1,400,000 per year.
• The project requires initial capital asset investment (at T=0) - a production machine worth $2,00,000. The value of the production machine is to be depreciated straight-line to zero over 14 YEARS (note: even though the project takes only 7 years, it is very well possible that the time of depreciation may be completely different from the maturity of the project.). It is expected that the production machine will be sold after 7 years for the (salvage) price of $1,000,000.
• In addition, the project requires the purchase of land worth $4,000,000 to be paid in cash. The land is not to be depreciated and it is not expected to gain or lose value in the next 7 years.
• If the project is undertaken, then in year 8 (the first year after the end of the production), after-tax land cleanup costs of $300,000 are to be paid by your client.
• Initial net working capital investment is $60,000 (to be paid immediately) and NWC levels are expected to increase by $5,000 throughout the life of the project (that is, every year, the NWC level is supposed to be $5,000 higher than the previous year's level).
• The tax rate is 21% and the required rate of return is 11%.

Problem 1: If the company decides to undertake the project, what are the annual levels of total free cash flows associated with the projects in years 0,1,2,...8?

Problem 2: What is the NPV of the project?

Problem 3: What is the Internal Rate of Return (IRR) of the project?

Problem 4: Ultimately, should the company undertake this project?