Dave Alvin, the CFO of Blasters Powertrain Products (BPP) hasrequested your assistance in evaluating a capital budgetingproposal. The proposal involves the production of a new line ofgearboxes for use in heavy freight applications. Research anddevelopment costs to develop this new line of gearboxes were$570,000 last year (2018). Production of the new product wouldrequire investment in (i.e., the purchase of) new machinery at acost of $6.6 million, with a useful life of 4 years. BPP hasconferred with its tax accountant and has been informed that theymust depreciate the machinery under the MACRs 5-year class. (Seepage 4 for a MACRS depreciation schedule.) Forecasts indicate thatthe machinery can be sold for a market value of $270,480 at the endof the 4-year period.

Management expects sales to be $7.65 million in year 1, andsales are projected to increase by 6%/year over the life of theproject. Variable production costs are projected to be $5.85million in year 1 and management expects these costs to increase by2%/year over the life of the project. Fixed production costs forthe gearboxes are expected to be $165,000 each year.

If BPP produces the new line of gearboxes, BPP will need to makeadditional investments in Net Working Capital (NWC) to support theincreased operations. In particular, NWC (entering any year) isexpected to be 10% of the projected sales for that year. That is,the NWC balance at t=0 would be 10% of the projected sales for year1, the NWC balance at t=1 would be 10% of the projected sales fort=2, and so on. The cumulative investments in NWC made as a resultof this project would be recovered in the project's final year. Inother words, the NWC balance will drop to $0 at t = 4.

The discount rate (also called cost of capital) used to evaluatethis project would be 9.06% (although this variable is not neededin this problem, given the instructions below), and the relevanttax rate is 25.00%.

Develop the incremental cash flow projections for thisproposal. Your worksheet should resemble the numerous examplescovered in Lesson 6, including the terms relating to “operating”cash flows, ?NWC, and net capital spending. Of course, any givencolumn in your worksheet should contain the total cash flow forthat column. [Note: Normally, you would then use these cash flowsto calculate NPV and IRR of the decision to start the new line ofgearboxes or (2) do nothing. If NPV > 0 (and, equivalently, IRR> required return), then the firm will choose option 1. If NPV< 0 (and, equivalently, IRR < required return), then the firmwill choose option 2. However, this assignment already contains anadequate number of other NPV and IRR calculations.]