Reference no: EM131974328

Electric Boat Corporation (“EB C”) designs, manu factures, and markets several lines of sporting boats desig ned to be powered by proprietary electric engines . The company is evaluating th e development of a new line of power boat called the Cruiser 2, and this would require an expansion of its production plant to enable it t o produce the Cruiser 2 for the next 5 years. La st year, the company spent $3 75 ,000 to do marketing research analysis to estimate market demand for a new power boat line . The company also spent last year $ 250 ,0 00 for an engin eering analysis for the new electric engine for the Cruiser 2 . The current expansion scenario would have total construction costs of $ 12 .3 million and it would take about 120 days to complet e (i.e., essentially up - front). EBC would also put in $ 9 .13 million of new production machinery and equipment. Inventory (raw materials, work - in - process, finished goods) investment needed for the expans ion to get start ed would be $4 .3 3 million . Except fo r the inventory investment, the total upfront investment can be completely depreciated assuming no salvage value using th e straight - line method over four (4) years (which is comparable to an accelerated depreciation method for income tax purposes) . T he company expects to incur $1 . 3 million in incremental annual interest expense, and the company expects it could in crease annual dividends by $0. 1 5 per share (there are 10 million shares outstanding). Incremental sales for this project ar e b ased on forecast demand of 530 units in the first year; 580 units in the second year; 6 3 0 units in the thir d year; 65 0 un its in the fourth year; and, 6 2 0 units in the fifth year . Average sales price per unit is expec ted to be $75,000 in Year 1; $78 ,000 in Year 2; $82,000 in Year 4; $86,000 in Year 4; and $92,5 00 in Year 5. Cost of goods sold is estimated to be 75 % of total sales each year, and incremental fi xe d costs are estimated to be $2.1 million per year. At the end of the project’s estimated life, the company estimates it could sell the purchased machinery a nd equipment for $ 1.5 million and the expected the book value for these items would be zero at that time . Als o at the end of the project, $0.8 30 million of inventory could be liquidated at its original cost (with no income tax effect). The company’s in co me tax rate is expected to be 39 % for ordinary income and 21 % for capital gains income. If EB C does this project, it will immediately sell some existing sur plus equipment for a price of $2 . 15 million which has a current book value of $ 1.80 million and whic h would have future depreciation of $ 450 ,000 per year for the next four years. EB C’s weight ed average cost of capital is 17 .5 0%, and EB C it believes this project should earn at least a 20.0 0% average annual return. Put the solutions to the following question s in to an Excel spreadshee t with appropriate detail, and use whole dollars in the spreadsheet. 1. What is the upfront total after - tax cash costs for this proposed project? 2 . What are the Total Annual Free Cash Flow s for Year 1? Year 2? Year 3 ? 3. What is the Total After - Tax Operating Cash Flow for Year 5 (exclude Terminal Year - specific items)? 4 . What is Terminal Year - specific Cash Flow (i.e., After - Tax Salvage Value excluding the Annual Operating Cash Flow portion)? Show your work in approp riate detail. 5. Is(Are) there any irrelevant cash flow(s) mentioned in this problem? If so, what is(are) it(they)? 6 . Ar e there any sunk costs for this project? If so, what are they? 7. Are there any opportunity costs for this project? If so, what are they? 8 . What is the Net Present Va lue for this project proposal? 9. What is the Internal Rate of Return for this project proposal? 10 . Would this project be a good investment? Why? (Calculate at least two capital budgeting evaluation methods but use only one to decide if the proposed project is a good investment).