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    ABC Manufacturing - Incremental Cash Flow and NPV

    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 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 $100,000. Assume that there is no 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 we need to:

    1. Prepare a statement showing the incremental cash flows for this project over an 8-year period.
    2. Calculate the payback period and the NPV for the project.
    3. Based on your answer above, do you think that the project should be accepted? Assume the ABC has a P/B policy of not accepting projects with a life of over three years.
    4. If the project required additional investment in land and building, how would this affect your decision?

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    Solution Preview

    1. The calculations are attached as well and sales figures are also given. The direct costs are 55% of the sales. We also include the incremental indirect costs since they are incremental and hence are increasing due to this project. The plant costs 1,000,000 and the depreciation would be 200,000 per year over 5 years with straight line. The initial investment is 1,000,000 in plant and 100,000 in working capital. Since we are doing analysis over 8 years, once ...