What are the cash flows for the project for each year

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Reference no: EM133331781

Question: Mark is the CEO of an agriculture products retailer. He is considering the purchase of a new software system to help with his new online retail venture. The software will cost $650,000, and will be depreciated straight-line over five years (to zero). Mark does not think the software will be viable after 4 years, however, because the developer will no longer support the product. Even worse, he thinks he will need to pay a programmer $10,000 at the end of year 4 to get rid of the software at that time. The software will have several effects if it is installed. First, it will reduce overhead expense by $20,000 per year due to savings in hardware needs. Second, it will reduce labor expenses for custom programming by $100,000 per year. Lastly, due to its sophisticated inventory management system, it will allow Mark to reduce inventory by $200,000 when he buys the software. The lower inventory can be maintained as long as the software is in use. The company has a target debt/equity ratio of 0.3 which they plan to maintain after adoption of the new software. Its current equity beta is 1.1. Mark plans on paying for the project out of cash raised from a new bank loan with an 7% interest rate (its marginal pre-tax cost of debt). He has identified a comparable pure play company in the online retail business, Omni Inc., that is unlevered, and has an equity beta of 1.4. Assume that the risk-free rate is 4%, the market risk premium is 7%, and all firms face a marginal tax rate of 30%.

1. What are the cash flows for the project for each year?

2. What discount rate should the firm use for the project?

3. Should Mark accept the project? Why or why not?

Reference no: EM133331781

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