Evergreen Company is investigating the feasibility of buying a new production line producing a new product. They project unit sales as in the below table, and they project price per unit to be $120 per unit at the beginning. And when competition catches up after 3 years (in the 4th year), they anticipate that the price would drop to $110. This project requires $20,000 in net working capital at the beginning. Subsequently, total net working capital at the end of each year would be about 15% of total sales for that year. The variable cost per unit is $60, and total fixed costs are $25,000 per year. It costs about $900,000 to buy the equipment necessary to begin the production. This investment is primarily in industrial equipment and falls in Class 8 with a CCA rate of 20%. The equipment will actually be worth about $150,000 in eight years. The relevant tax rate is 40% and the required return is 15%. Years     Unit Sales  1                3000 2                5000 3                6000 4                6500 5                6000 6                5000 7                4000 8                3000 On the other hand, Evergreen company is also considering replacing one of its old production lines with a new one with an advanced technology. It has undergone a market research last year that costed $120K which showed that there is an increase in demand for such a new technology .The new production line will cost $3M and is expected to have a salvage value in 6 years for $750K. The existing production line was bought 2 years ago for $1.2M, and can be sold today at a market value of $500K. If not sold now, this old machinery is expected to have a salvage value of $100K in 6 years. The project is expected to generate sales in year 1 for $4.2M and thereafter sales are forecasted to grow by 6% a year for the coming 6 years. This is as opposed to the current production line which was expected to generate $3.5M of sales next year and grows by 2% for the coming 6 years. Manufacturing costs are the same under both production lines. The new project requires an initial investment in working capital of $400k. Thereafter, working capital is forecasted to grow at the same growth rate of revenues of 6% (CCA rate is 20%, the asset class will remain open, tax rate is 40% & discount rate is 15%). Question 1  Calculate the NPV. Question 2  Calculate the IRR of the replacement project. Question 3  Should Evergreen company go ahead with the replacement project? Yes, No, or Indifferent

FINANCIAL ACCOUNTING
10th Edition
ISBN:9781259964947
Author:Libby
Publisher:Libby
Chapter1: Financial Statements And Business Decisions
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Evergreen Company is investigating the feasibility of buying a new production line producing a new product. They project unit sales as in the below table, and they project price per unit to be $120 per unit at the beginning. And when competition catches up after 3 years (in the 4th year), they anticipate that the price would drop to $110. This project requires $20,000 in net working capital at the beginning. Subsequently, total net working capital at the end of each year would be about 15% of total sales for that year. The variable cost per unit is $60, and total fixed costs are $25,000 per year. It costs about $900,000 to buy the equipment necessary to begin the production. This investment is primarily in industrial equipment and falls in Class 8 with a CCA rate of 20%. The equipment will actually be worth about $150,000 in eight years. The relevant tax rate is 40% and the required return is 15%.

Years     Unit Sales 

1                3000

2                5000

3                6000

4                6500

5                6000

6                5000

7                4000

8                3000

On the other hand, Evergreen company is also considering replacing one of its old production lines with a new one with an advanced technology. It has undergone a market research last year that costed $120K which showed that there is an increase in demand for such a new technology .The new production line will cost $3M and is expected to have a salvage value in 6 years for $750K. The existing production line was bought 2 years ago for $1.2M, and can be sold today at a market value of $500K. If not sold now, this old machinery is expected to have a salvage value of $100K in 6 years. The project is expected to generate sales in year 1 for $4.2M and thereafter sales are forecasted to grow by 6% a year for the coming 6 years. This is as opposed to the current production line which was expected to generate $3.5M of sales next year and grows by 2% for the coming 6 years. Manufacturing costs are the same under both production lines. The new project requires an initial investment in working capital of $400k. Thereafter, working capital is forecasted to grow at the same growth rate of revenues of 6% (CCA rate is 20%, the asset class will remain open, tax rate is 40% & discount rate is 15%).

Question 1 

Calculate the NPV.

Question 2 

Calculate the IRR of the replacement project.

Question 3 

Should Evergreen company go ahead with the replacement project? Yes, No, or Indifferent

 

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