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Capital budgeting. Company Inc. is going to invest, based on the marketing research that cost $10,000, into a new project $150,000 with the expectations that this venture will generate sales for the next five years as shown in an exhibit below. Variable cash operating expenses will be 50 percent of sales each year, and fixed cash operating expenses are $20,000 annually. Computation of depreciation is straight-line to zero book value within five year. The income tax rate is 40 percent. The value of the capital investment at the end of year 5 is $15,000 (estimated market value of an investment). The investment also requires additional working capital investments – the company needs to maintain 10% of the annual sales as an investment into working capital (hint: there will be changes in working capital each year). The required rate of return (WACC) is 12 percent.

Estimated sales revenues from an investment

Year	0	1	2	3	4	5
Sales		150 000	200 000	250 000	200 000	120 000

Questions:

Compute the incremental cash flows for the project (you are advised to use excel)
Estimate the NPV and IRR for the project. Should the company invest into this project?

pur-new-sol

marketing research cost is already paid and is a sunk cost

Net working capital is assumed to be required at the beginning of the year

The Incremental cashflows are calculated as shown below

Year	0	1	2	3	4	5
Sales		150000	200000	250000	200000	120000
Less :Variable Costs		75000	100000	125000	100000	60000
Less: Fixed costs		20000	20000	20000	20000	20000
Less: Depreciation		30000	30000	30000	30000	30000
Earnings before tax		25000	50000	75000	50000	10000
Less: Tax @40%		10000	20000	30000	20000	4000
Profit after tax		15000	30000	45000	30000	6000
Add: Depreciation		30000	30000	30000	30000	30000
Capital Cost	-150000
Net Working capital	15000	20000	25000	20000	12000	0
Change in Net working capital	15000	5000	5000	-5000	-8000	-12000
After tax Salvage Value						9000
Incremental Cashflows	-165000	40000	55000	80000	68000	57000

a) Incremental Cashflows for the project for various years of operation are shown in the last row of the table above (Figures in Dollars)

b) NPV of the project = -165000+40000/1.12+55000/1.12^2+80000/1.12^3+68000/1.12^4+57000/1.12^5

=$47060.93

IRR(r) of the project is given by

-165000+40000/(1+r)+55000/(1+r)^2+80000/(1+r)^3+68000/(1+r)^4+57000/(1+r)^5=0

Solving , r=0.2215 or 22.15%

As the NPV is positive as well as the IRR is greater than the WACC, the company should invest in the project

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