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A new production line will cost $3.6M and is expected to have a salvage value in 6 years for $750K. The existing production line was bought 2 years ago for $1.2M, and can be sold today at a market value of $400K. If not sold now, this old machinery is expected to have a salvage value of $100K in 6 years. The project is expected to generate sales in year 1 for $4.2M and thereafter sales are forecasted to grow by 4% a year for the coming 6 years. This is as opposed to the current production line which was expected to generate $3.5M of sales next year and grows by 2% for the coming 6 years. Manufacturing costs are the same under both production lines. The new projection line requires an initial investment in working capital of $400k. Thereafter, working capital is forecasted to grow at the same growth rate of revenues of 4%. CCA rate is 20%, and since this equipment will be purchased after January 2019, then the accelerated investment incentive (AII) can be applied.

Additional Info:

• The companys cost of capital = 12%

• The risk-free rate = 2%

• The market portfolio has an expected return of 9%

• The company has a beta of 1.74.

• The tax rate = 40%

1. Calculate the NPV and the IRR of the project of replacing the old production line with a new one with an advanced technology. Should the company proceed with replacing the production line? Explain.

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