You will assume that you still work as a financial analyst for Aero-Botics, Inc. The company is considering a capital investment in a new machine and you are in charge of making a recommendation on the purchase based on a given rate of return of 12%.
Task 4. Capital Budgeting for a New Machine
A few months have now passed and Aero-Botics, Inc. is considering the purchase on a new machine that will increase the production of a special component significantly. The anticipated cash flows for the project are as follows:
Year 1 $750,000
Year 2 $1,000,000
Year 3 $1,100,000
Year 4 $1,150,000
Year 5 $1,200,000
You have now been tasked with providing a recommendation for the project based on the results of a Net Present Value Analysis. Assuming that the required rate of return is 15% and the initial cost of the machine is $3,500,000.
1. What is the project's IRR?
2. What is the project's NPV?
3. Should the company accept this project and why (or why not)?
4. Explain how depreciation will affect the present value of the project.
5. Provide examples of at least one of the following as it relates to the project:
a. Sunk Cost
b. Opportunity cost
6. Explain how you would conduct a scenario and sensitivity analysis of the project. What would be some project-specific risks and market risks related to this project?
The problem set deals with issues in finance: net present value and internal rate of return.