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    Decisions Regarding Long-Term Financial Management

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    Superior Manufacturing is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 55% of sales. Indirect incremental costs are estimated at $80,000 a year. The project requires a new plant that will cost a total of $1,000,000, which will be depreciated straight line over the next five years. The new line will also require an additional net investment in inventory and receivables in the amount of $200,000. Assume there is no need for additional investment in building and land for the project. The firm's marginal tax rate is 35%, and its cost of capital is 10%. Based on this information you are to complete the following tasks.

    Prepare a statement showing the incremental cash flows for this project over an 8-year period.

    Calculate the Payback Period (P/B) and the NPV for the project.

    Based on your answer for question 2, do you think the project should be accepted? Why? Assume Superior has a P/B (payback) policy of not accepting projects with life of over three years.

    If the project required additional investment in land and building, how would this affect your decision? Explain.

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    Solution Preview

    The investment decisions of a firm are generally known as the capital budgeting, or capital expenditure decisions. The firm's investment decisions would generally include expansion, acquisition, modernization and replacement of the long-term assets. Sale of a division or business (divestment) is also as an investment decision.
    Decisions like the change in the methods of sales distribution, or an advertisement campaign or research and development programs have long-term implications for the firm's expenditures and benefits, and therefore, they should also be evaluated as investment decisions. Several different procedures are available to analyze potential business investments. Some concepts are better than others when it comes to reliability but all provide enough information to get the general scope of the investment. The five procedures that provide useful information are the Net present Value ...

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