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incremental cash flows

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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.

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

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

3. 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.

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

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Solution Summary

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

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Capital Budgeting Project - Net Cash Flow, Incremental Cash Flows, NPV and IRR

POLO may upgrade its "modem pool." It last upgraded two years ago, when it spent $115 million dollars on equipment with an assumed life of 5 years. The firm uses straight-line depreciation (to 0.00). The old equipment can be sold today for $30 million. A new modem pool can be installed today for $150 million. New equipment will have a 3 year life, and will be depreciated to zero using straight-line depreciation. The new equipment will enable Polo to increase sales by $25 million per year and decrease operating costs by $10 million per year. At the end of 3 years, the new equipment will be worthless. Assume the firm's tax rate is 35% at that time and the discount rate for projects of this sort is 12%

a) What is the net cash flow at time period "0" if the old equipment is replaced?

b) What are the incremental cash flows in years 1, 2, and 3?

c) What are the NPV and the IRR of the replacement project?

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