You are considering investing in a new line of entertainment products. The project has an estimated economic life of 5 years. You anticipate some immediate startup costs amounting to $25,000.
In addition, you will be investing $100,000 in new plant and equipment. Assume, for tax purposes, that the machinery and equipment will be depreciated straight-line over its economic life. Also assume that the initial startup costs are fully tax-deductible.
In the first year of operation you are anticipating sales revenues of $60,000. These revenues are expected to grow by 5% per year until year 4; however, the revenues are expected to decline by 5% in the fifth year. First-year operating costs will be $10,000; in subsequent years, these are expected to grow in proportion to sales revenues. The tax rate applicable to your business will be 34%. Also, at the end of the project’s economic life, your plant and equipment will not have any salvage value. Your cost of capital is 12%.
Assuming that you will be able to expense the project’s startup costs,
a. Calculate its payback period, discounted payback period, internal rate of return, net present value, and profitability index.
b. Using the net present value and internal rate of return criteria, do you think it is worthwhile for you to pursue this project? Explain your answer.
c. Now, assume that for CCA purposes, your plant and equipment belong to asset Class 39. Which carries a CCA rate of 25%. Recomputed the project’s net present value, assuming that you have other assets in asset Class 39 that will be continued even after the economic life of this project is over. Work out your calculations separately assuming (1) a zero salvage value and (2) a $10,000 salvage value, at the end of the project’s economic life. Would you pursue the project under these new conditions? Explain your answer.