Monica is a senior financial manager of Eclipse Ltd. She is conducting a capital budgeting analysis on a new product. She has already authorised an extensive market research on the marketability of the product that cost $15,000, which she paid yesterday. The new project is expected to generate yearly revenue of $390,000 for 4 years. The related variable costs are expected to be $100,000 p.a. and Monica estimates the relevant fixed costs would be another $30,000 p.a. The project will require the company to purchase new equipment at a cost of $500,000. The new equipment will be installed in a building which the company already owns but the building is currently left vacant. The company will depreciate the equipment by the straight-line method to zero salvage value over the 4 years and Monica believes that they can sell the equipment at the end of 4 years for $20,000. Eclipse Ltd’s required payback is 3 years and the required rate of return is 12% p.a. The relevant tax rate is 30% and tax is paid in the year in which earnings are received. Calculate the incremental cash flows of the new project for each year (Y0 to Y4 inclusive). Calculate the payback period of the project. (Show answer correct to 2 decimal places.) Calculate the net present value (NPV) of the project. (Show answer correct to 2 decimal places.)

Corporate Fin Focused Approach

5th Edition

ISBN:9781285660516

Author:EHRHARDT

Publisher:EHRHARDT

Chapter11: Cash Flow Estimation And Risk Analysis

Section: Chapter Questions

Problem 1iM

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Monica is a senior financial manager of Eclipse Ltd. She is conducting a capital budgeting analysis on a new product. She has already authorised an extensive market research on the marketability of the product that cost $15,000, which she paid yesterday.

The new project is expected to generate yearly revenue of $390,000 for 4 years. The related variable costs are expected to be $100,000 p.a. and Monica estimates the relevant fixed costs would be another $30,000 p.a.

The project will require the company to purchase new equipment at a cost of $500,000. The new equipment will be installed in a building which the company already owns but the building is currently left vacant.

The company will depreciate the equipment by the straight-line method to zero salvage value over the 4 years and Monica believes that they can sell the equipment at the end of 4 years for $20,000.

Eclipse Ltd’s required payback is 3 years and the required rate of return is 12% p.a. The relevant tax rate is 30% and tax is paid in the year in which earnings are received.

Calculate the incremental cash flows of the new project for each year (Y0 to Y4 inclusive).
Calculate the payback period of the project. (Show answer correct to 2 decimal places.)
Calculate the net present value (NPV) of the project. (Show answer correct to 2 decimal places.)
Calculate the present value index of the project. (Show answer correct to 4 decimal places.)
Should Monica accept this project? Why or why not?

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