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Based on a feasibility study conducted at a cost of $65,000, Star Manufacturing is considering building a new production facility. The company has asked you to evaluate whether the project should be undertaken. To help with your analysis, management has provided you with the following information:

The project will require an initial investment of $1.85 million in a new factory. The company has adopted a 6-year planning horizon, after which it intends to re-evaluate the investment. The factory will be built on a block of land that is being purchased for $1.3 million. Land values are projected to grow at an average rate of 7% per annum for the foreseeable future. The project will also require an additional investment of $800,000 in net working capital. Net revenues have been projected at $2 mil per annum over the six-year period.

Finally, the factory is expected to have a salvage value of $700,000 at the end of the project and the analysis is to be undertaken on the assumption that the land and the factory will all be sold at the end of the project. The firms tax rate is 35%, and its cost of capital is 12% and the CCA rate to be used for the factory is 25%.

Required:

Using the net present value (NPV) method advise the company whether the project should be undertaken. (20 marks)

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