We are considering the introduction of a new product. Currently we are in the 20% tax bracket with a 10% discount rate. This project is expected to last five years and then, because this is somewhat of a fad project, it will be terminated. The following information describes the new project:

Cost of new plant and equipment: $ 8,500,000

Shipping and installation costs: $ 375,000

Unit sales: 1 100,000 units

2 110,000 units

3 120,000 units

4 110,000 units

5 100,000 units

Sales price per unit: $500/unit in years 1–4 and

$450/unit in year 5.

Variable cost per unit - $210

Annual fixed costs - $300,000 per year

Working capital requirements: There will be an initial working capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will be equal to 10% of the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5.

Depreciation method: Straight-line over 5 years assuming the plant and equipment have no salvage value after 5 years.

**Questions**

1. Why should Caledonia focus on project free cash flows as opposed to the accounting profits earned by the project when analyzing whether to undertake the project?

2. What are the incremental cash flows for the project in years 1 through 5 and how do these cash flows differ from accounting profits or earnings?

3. What is the project’s initial outlay?

4. Sketch out a cash flow diagram for this project.

5. What is the project’s net present value?

6. What is its internal rate of return?

7. Should the project be accepted? Why or why not?

Subject | Mathematics |

Due By (Pacific Time) | 08/10/2013 06:30 pm |

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