Reference no: EM133183405

Question - The company has received a request to deliver a project for a customer. The project will provide an expected revenue of $1.9 million each year over the next four years. The variable cost each year is expected to be 35% of sales.

If the company accepts the new project, they will have to make a new investment of $2 million in equipment. The investment in equipment is to be depreciated over the life of the project on a straight-line basis and has a salvage value of 200,000 with a contract for sale in year four.

In addition, other fixed costs, excluding interest cost, are expected to increase by $350,000 each year.

To finance the investment, the company intends to take up a bank loan for $800,000 at the beginning of the period and will repay the loan in one lump sum in year four. The interest is expected to be 8% and will be paid at the end of each year.

The company expects to receive an advance payment of $300,000 from the customer for the project as a deposit. The deposit will be refunded in full to the customer once the project is fully complete.

Assume that the tax rate is 23%.

Required -

1. Given that the company has a relevant cost of capital of 15%, would you advise them to conduct this project? Explain your answer.

2. What is the internal rate of return and what does that tell you?