Question

FITCO Inc. is the manufacturer of exercise machines and is considering producing a new line of equipment in an effort to increase its market share. The new production line will cost $1,550,000 for manufacturing the parts and an additional $130,000 is needed for installation. The equipment falls into the MACRS 3-yr class, and would be sold after four years for $400,000.

The equipment line will generate additional annual revenues of $865,000, and will have additional annual operating expenses of $500,000. An inventory investment of $90,000 is required during the life of the project. FITCO is in the 35 percent tax bracket, and its existing cost of capital is 6 percent.

A. Calculate the initial outlay of the project. (3 points)

B. Calculate the annual after-tax operating cash flow for Years 1 -4. (8 points)

C. Determine the terminal year (in year 4) after-tax non-operating cash flow. (3 points)

D. What is the equipment’s NPV? (3 points)

E. What is the estimated Internal Rate of Return (IRR) of the project? Should the project be accepted based on the IRR criterion?