Contact Techs Board was so impressed with Rachel Rollins analysis that they expanded her financial analysis department. Rachel has hired your team to help her evaluate a potential new project for the company.

The company just finished a project in a manufacturing plant that could be modified and used for this new project manufacturing materials for microprocessor chips used in automobiles and computers. Contact Tech sees this as a 5-year project to help fill the national and world-wide microprocessor chip shortage.

Initial costs (t=0) include plant modification and equipment costs totaling $4,000,000. Contact Tech estimates that they will have more than sufficient operating income to write off (expense) the cost of the project which allows the project to qualify for immediate 100% Bonus Depreciation. Also, the project would require and initial increase in net operating working capital of $350,000.

Last year, the company spent $500,000 repairing some damage caused by the previous project in the manufacturing plant that would be used by this proposed project. Some members of Contacts accounting and treasury department suggest that this repair cost which has already been paid and expensed for tax purposes should be charged against this microprocessor materials project. Their rationale is that the company would have to spend this $500,000 to make the plant suitable for the proposed new project.

In terms of annual operating cash flows, the company forecasts the following sales price & variable cost per unit and unit sales.

Year	Sales price per unit	Variable cost per unit	Unit Sales
1	$50	$24	100,000
2	$49	$25	85,000
3	$47	$26	75,000
4	$45	$28	70,000
5	$44	$30	60,000

The company forecasts year 1 fixed costs of $400,000 annually that are expected to increase $50,000 annually and a tax rate of 25%.

At the end of the 5-year life of the project, the equipment has an expected salvage value of $600,000 and the initial increase in net operating working capital would be liquidated (recovered).

Part II Questions

1. Should the $500,000 spent last year to repair the manufacturing plant be included in the project analysis?
2. Suppose another manufacturer expressed interest in leasing the plant for $700,000 a year. Explain how this information would be incorporated in the analysis if this were true (in fact it was not)?
3. What is Contact Techs Year 0 total initial investment outlay for the proposed project?

1. Estimate the projects operating cash flows for years 1 through 5.
2. What is the expected non-operating (terminal) cash flow when the project is terminated at the end of Year 5?
3. Using a WACC of 10%, what is the projects NPV and IRR? Should the project be undertaken?

Part 3: To replace or not to replace? That is the question.

Dill Corporation, a sports equipment manufacturer, has a machine in use that was originally purchased 6 years ago for $200,000. The firm depreciates the machine under 10-year simplified straight-line depreciation (4 years depreciation remaining) to zero. Once removal and cleanup costs are taken into consideration, the expected net selling price for the present machine today will be $90,000. Dill can buy a new machine for a net price of $300,000 (including installation costs of $15,000). The proposed machine will qualify for immediate year 0 expensing under 100% bonus depreciation. If the firm acquires the new machine, its working capital needs will changeaccounts receivable will increase $20,000, inventory will increase $25,000, and accounts payable will increase $22,000. Earnings before depreciation, interest, and taxes (EBITDA) for the present machine are expected to be $80,000 for each of the successive 5 years. For the proposed machine, the expected EBITDA for each of the next 5 years are $140,000, $140,000, $135,000, $135,000, and $130,000, respectively. The corporate tax rate for the firm is 25%. Dill expects to be able to liquidate the proposed machine at the end of its 5-year usable life for $44,000. The present machine is expected to bring in $10,000 upon liquidation at the end of the same time period. Dill expects to recover its net working capital investment upon termination of the project. The firm is subject to a tax rate of 25%. Assignment (in your spreadsheet)

1. Calculate the initial investment or outlay for this replacement project.
2. Calculate the relevant operating cash flows for the replacement project analysis.
3. Calculate the terminal cash flow associated with this replacement project.
4. Should Dill go ahead with this replacement project if the WACC for the project is 12%? Support your decision.