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ABC Manufacturing is thinking of launching a new product. The company expects to sell $900,000 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 will require a new plant that will cost a total of $1000,000 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 100,000. Assume there is not need for additional investment in building and land for the project. The firm's marginal tax rate is 40%, 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 and the NPV for the project.

Based on your answer for question 2, do you think the project should be accepted? Why? Assume ABC has a P/B 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 provided by:
Gaurav Agarwal, MS
Education
  • BE, Bangalore University, India
  • MS, University of Wisconsin-Madison
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