Sophisticated Widgets Inc. is considering an investment project that will require an initial investment of $200,000 in net working capital and have an estimated life of 5 years. The project’s incremental sales are expected to be 300,000 units at a price of $15 per unit for the first year. The price per unit is expected to grow at the rate of inflation of 3% per year. The variable costs will represent 65% of annual revenues and the fixed costs will be $800,000 annually. The capital spending associated with the project will cost $1,900,000 and will require an additional $150,000 of shipping and installation expenses. The fixed assets associated with the project will be depreciated using the MACRS 7-year class life. After five years the project’s fixed assets can be sold for $350,000.
The WACC is 15% and the marginal tax rate is 40%.
a) Calculate the initial investment, annual after-tax cash flows, and the terminal cash flow of this investment project.
b) Determine the payback period, discounted payback period, NPV, PI, IRR, and MIRR of this project. Should this project be accepted?
c) Perform the same sensitivity analysis as that in Exhibit 13-5, page 402 (except that you should use increments of 5% from -15% to 15%) for the following uncertain variables: number of units, variable cost as a percentage of sales, investment in net working capital, salvage value, and inflation rate. Create a sensitivity diagram that includes all of these variables.
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