Superior Manufacturing is thinking of launching a new product
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.
1)
Please see the attached excel sheet
2)
The only amount that needs to be recovered in Year 3 is $447,375, and the cash flow is $456,750, this means that the $447,375 would be recovered in a fraction of year 3. To calculate that fraction:
$447,375 / $456,750 = 0.98
Payback Period = 2.98 years
NPV = $1,075,689
3)
Since the NPV is positive, the project should be accepted. Using the payback period criterion, the project should be accepted since it has a payback period that is less than 3 years.
4)
The payback period under the current scenario is close to 3 years which is the screening tool set by Superior Manufacturing hence if additional investment in land and building is required, the increase in cost would cause an increase in the payback period, which in turn would lead the project to be rejected.
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