Question: Artistic Clothing is considering an extension project which includes the construction of a new manufacturing...

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Question: Artistic Clothing is considering an extension projectwhich includes the construction of a new manufacturing warehouse.The required initial investment for the construction is $2 million.the warehouse will be depreciated over 10 years on a straight-linebasis with no residual value at the end of year 10. Also, companyalso plans to use its own land for the project which is currentlyhired to other company to use as a warehouse. The estimated rentalincome that will be missed over the project life is $300,000 valuedas of today. To start the production, Artistic Clothing needs toinvest in net working
capital the total amount of $200,000 at the beginning of theproject. This investment will be recovered at the end of theproject.
Company also expects to generate an annual revenue of $650,000,its associated cost of sales and operating expense are $250,000.Tax rate is 30%.
a. Determine the cash flows of the project from year 1 to year10.
b. If company requires a rate of return of 10% from the project,should this project be accepted?
c. Calculate the payback period. If the company requires apayback period of less than 6 years, should the project beaccepted?

Answer & Explanation Solved by verified expert

3.7 Ratings (484 Votes)

a. Cash flows:

Year	Contribution reced.	dep	IBT	IAT	Cash Flow	discount 10%	PV
0	-2200000				-2200000	1	-2200000
1	400000	200000	200000	140000	340000	0.909	309060
2	400000	200000	200000	140000	340000	0.826	280840
3	400000	200000	200000	140000	340000	0.751	255340
4	400000	200000	200000	140000	340000	0.683	232220
5	400000	200000	200000	140000	340000	0.621	211140
6	400000	200000	200000	140000	340000	0.564	191760
7	400000	200000	200000	140000	340000	0.513	174420
8	400000	200000	200000	140000	340000	0.467	158780
9	400000	200000	200000	140000	340000	0.424	144160
10	400000	200000	200000	140000	340000	0.386	131240
working capital					200000	0.386	77200
NPV							-33840

b) No, the project should not be accepted as NPV is negative.
Moreover, off-project the rental incomes present value is $300000.

c) The payback period of the project is $2m/0.4m = 5 years and as per
criteria of acceptance lower to 6 years, the should be accepted.

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Question: Artistic Clothing is considering an extension projectwhich includes the construction of a new manufacturing warehouse.The required initial investment for the construction is $2 million.the warehouse will be depreciated over 10 years on a straight-linebasis with no residual value at the end of year 10. Also, companyalso plans to use its own land for the project which is currentlyhired to other company to use as a warehouse. The estimated rentalincome that will be missed over the project life is $300,000 valuedas of today. To start the production, Artistic Clothing needs toinvest in net workingcapital the total amount of $200,000 at the beginning of theproject. This investment will be recovered at the end of theproject.Company also expects to generate an annual revenue of $650,000,its associated cost of sales and operating expense are $250,000.Tax rate is 30%.a. Determine the cash flows of the project from year 1 to year10.b. If company requires a rate of return of 10% from the project,should this project be accepted?c. Calculate the payback period. If the company requires apayback period of less than 6 years, should the project beaccepted?