Investment in Working Capital

The Doraville Machinery Company is planning to expand its current spindle product line. The required machinery would cost $500,000. The building that will house the new production facility would cost $1.5 million. The land would cost $250,000, and $150,000 working capital would be required. The product is expected to result in additional sales of $675,000 per year for 10 years, at which time the land can be sold for $500,000, the building for $700,000, and the equipment for $50,000. All of the working capital will be recovered. The annual disbursements for labor, materials, and all other expenses are estimated to be $425,000. The firm’s income tax rate is 40%, and any capital gains will be taxed at 35%. The building will be depreciated according to a 39 year property class. The manufacturing facility will be classified as a 7 year MACRS. The firm’s MARR is known to be 15% after taxes.

(a) Determine the projected net after tax cash flows from this investment. Is the expansion justified?

(b) Compare the IRR of this project with that of a situation with no working capital.