Capital budgeting
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10-12A. (Comprehensive problem) Traid Winds Corporation, a firm in the 34 percent marginal tax
bracket with a 15 percent required rate of return or cost of capital, is considering a new project.
This project involves the introduction of a new product. This project is expected to last five years
and then, because this is somewhat of a fad project, to be terminated. Given the following information,
determine the free cash flows associated with the project, the project's net present value, the
profitability index, and the internal rate of return. Apply the appropriate decision criteria.
Cost of new plant and equipment: $14,800,000
Shipping and installation costs: $ 200,000
Unit sales: Year Units Sold
1 70,000
2 120,000
3 120,000
4 80,000
5 70,000
Sales price per unit: $300/unit in years 1-4, $250/unit in year 5
Variable cost per unit: $140/unit
Annual fixed costs: $700,000
Working-capital requirements: There will be an initial working-capital requirement of $200,000 just to get
production started. For each year, the total investment in net working capital will be equal to 10 percent of
the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1
through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project
at the end of year 5.
The depreciation method: Use the simplified straight-line method over five years. It is assumed that the
plant and equipment will have no salvage value after five years
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Solution Summary
The solution explains the calculation of free cash flows and taking the accept/reject decision
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