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    Using Payback Period and NPV to Judge a Project

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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 policy of not accepting projects with life or 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 Summary

    The solution provides answers to questions on capital budgeting (NPV, payback) for Superior Manufacturing. Calculations are given in an attached Excel file an explanations are given.