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QUESTION

The project has a useful life of 10 years. Land costs $5m and is estimated to have a resale value of $7m at the completion of the project.

The project has a useful life of 10 years.

Land costs $5m and is estimated to have a resale value of $7m at the completion of the project.

Buildings cost $4m, with allowable depreciation of 5% pa straight-line and a salvage value of $0.8m.

Equipment costs $3m, with allowable depreciation of 20% pa straight-line and a salvage value of $0.4m. An investment allowance of 20% of the equipment cost is available.

Revenues are expected to be $5m in year one and rise at 10% pa.

Cash expenses are estimated at $2m in year one and rise at 5% pa.

The new product will be charged $300,000 of allocated head office administration costs each year even though head office will not actually incur any extra costs to manage the project. 

An amount of $200,000 has been spent on a feasibility study for the new project. 

The project is to be partially financed with a loan of $6m to be repaid annually with equal instalments at a rate of 5% pa over 10 years.

Except for initial outlays, assume cash flows occur at the end of each year.

The tax rate is 30% and is payable in the year in which profit is earned. 

The after tax required return for the project is 10% pa.

Find:

(a)  Calculate the NPV. Is the project acceptable? Why or why not?

(b) Conduct a sensitivity analysis showing how sensitive the project is to revenues, cash expenses and to the cost of capital. Explain your results.

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