As the financial advisor to All Star Manufacturing you are evaluating the following new investment in a manufacturing project: –
The project has a useful life of 8 years.
Land costs $10m and is estimated to have a resale value of $15m at the completion of the project.
Buildings cost $12m, with allowable depreciation of 6% pa reducing balance and a salvage value of $10m.
Equipment costs $5m, with allowable depreciation of 10% pa reducing balance and a salvage value of $1m. An investment allowance of 20% of the equipment cost is available.
Revenues are expected to be $15m in year one and rise at 5% pa.
Cash variable costs are estimated at 30% of revenue.
Cash fixed costs are estimated at $3m pa.
Managerial salaries of $800,000 will be allocated to the project, but these managerial positions will be unaffected by the acceptance of the project.
An amount of $200,000 has been spent on a feasibility study for the new project.
The project is to be partially financed with a loan of $13.5m to be repaid annually with equal instalments at a rate of 5% pa over 8 years.
Except for initial outlays, assume cash flows occur at the end of each year.
The tax rate is 30% and is payable in the year in which profit is earned.
The after-tax required return for the project is 11% pa.
Required
(a) Calculate the NPV. Is the project acceptable? Why or why not?
(b) Conduct a sensitivity analysis showing how sensitive the project is to revenues, fixed costs and to the required rate of return. Explain your results.