1) You are the assistant to the CFO of ABC Inc. divisions A, B and C have ach proposed projects that require a $1,000,000 cash investment. The CFO has asked you to analyze the projects and recommend which project he should fund.
ABC Inc. has a required rate of return of 15% risk adjusted.
ABC Inc. always uses a tax rate of 40% in investment analysis.
Project A is a long lived project. Net Revenues (sales less operating costs) are expected to be $300,000 per year for 18 years. All of the investment will go into equipment that will be depreciated using the straight lime method over 10 years.
The equipment will have no salvage value at the end of 18 years.
Project B is a medium term project. Net revenues are expected to be $375,000 per year for 7 years. The investment is $800,000 in depreciable equipment and $100,000 increase in working capital, which will be recaptured at the end of the project and $100,000 in training. The equipment will be depreciated straight line over 7 years and will have a salvage value of $100,000 due to the value of the scrap metals in the equipment.
Project C is a short term project. Net revenues are expected to be $415,000 per year for 4 years. The investment is $400,000 in equipment that is depreciated straight line and has a salvage value of $50,000. The remaining $600,000 goes into working capital of which $500,000 will be recaptured at the end of 4 years.
Which project do you recommend?
Does your recommendation change if the required rate of return falls to 12%.
Does your recommendation change if the required rate of return rises to 20%.