The corporation is producing at full capacity, Kelly has decided to have Dan examine the feasibility of a new manufacturing plant. This expansion would represent a major capital outlay for the company. A preliminary analysis of the project has been conducted at a cost of $1.6 million.
This analysis determined that the new plant will require an immediate outlay of $54 million and an additional outlay of $31 million in one year. The company has received a special tax dispensation that will allow the building and equipment to be depreciated on a 20-year MACRS schedule.
Because of the time necessary to build the new plant, no sales will be possible for the next year. Two years from now, the company will have partial-year sales of $17 million. Sales in the following four years will be $28 million, $37 million, $40 million, and $43 million. Because the new plant will be more efficient than the corporation’s current manufacturing facilities, variable costs are expected to be 65 percent of sales, and fixed costs will be $2.4 million per year. The new plant will also require net working capital amounting to 8 percent of sales for the next year.
Dan realizes that sales from the new plant will continue into the indefinite future. Because of this, he believes the cash flows after Year 5 will continue to grow at 2.5 percent indefinitely. The company’s tax rate is 40 percent and the required return is 12 percent.
After the empirical results, Dan would like to provide the recommendation to Kelly and Board of directors, what is Han’s recommendation? Kelly also wants Dan to provide a sensitivity analysis and change any one of elements documented before and see what happens? For example, increase or decrease growth rate and at what level the firm can break even when NPV=0.
