Chill Mount Creamery manufactures a variety of Ice creams. The company
is considering introducing a new product (Yugo cream). The company’s
manager has been provided with the following information by their
? The project has an anticipated economic life of 5 years.
?The Company plans to spend $1,300,000 on advertising campaign to boost sales.
?The Company’s interest expense each year will be $500,000.
The Company is required to purchase a new machine to produce the new
product. The machine’s initial cost is $5,500,000. The machine will be
depreciated on a straight – line basis over 5 years. The Company
anticipates that the machine will last for 10 years; the salvage value
after 5 years is $500,000.
? Six months ago the Company also paid $300,000 to a firm to do research regarding new product.
If the Company goes ahead with the new product, it will have an effect
on the Company’s net operating capital. The forecasted net working
capital will be $200,000 (at time zero)
? The new product is expected
to generate sales revenue of $1,500,000, 2,500,000, 3,500,000, 4500,000
and 5,500,000 in year 1, 2, 3, 4 and 5 respectively. Each year the
operating cost (not including depreciation) expected to equal 30 percent
of sales revenue.
? In addition the Company expects with
introduction of new product, sale of other ice cream increase by
$500,000 after taxes each year.
? The Company’s overall WACC is 7.5
percent. However, the proposed project is riskier than the average
project; the new project’s WACC is estimated to be 10 percent.
? The Company’s tax rate is 30 percent.
What is the net present value, internal rate of return, payback period,
discounted payback period, and profitability index of the proposed
project. Based on your analysis should the project be accepted? Discuss.