XYZ Corporation is considering the introduction of a new product.

The project will last five years and then be terminated.

The company’s marginal tax rate is 32%.

The company’s cost of capital is 18%.

The cost of the new plant and equipment for the project is $6,000,000.

Shipping and Installation costs are $100,000.

Projected sales are:

            Year    Units Sold

1                60,000

2                110,000

3                130,000

4                90,000

5                80,000

Sales price per unit:

$125 per unit in years 1-3

$110 per unit in year 4

$90 per unit in year 5

Variable cost per unit: $75 per unit.

Annual fixed costs: $225,000.

Initial Working Capital Required is $250,000 to start the project.

For each year, the total investment in net working capital will be equal to 10% of sales.  All working capital is liquidated at the termination of the project at the end of year 5.

Depreciation method:  Use simplified straight-line depreciation over five years.  It is assumed the plant and equipment will have no salvage value at the end of the project.


Based on the above information, answer the following question:


  1. Explain how incremental free cash flows differ from accounting profits.
  2. Why should XYZ Corporation focus on the project free cash flows as opposed to the accounting profits earned by the project?
  3. Produce a calculation of free cash flows worksheet for this project, similar to the spreadsheet included in the Capital Budget Example provided in the Course Materials Forum on eCampus.
  4. What is the project’s initial outlay?
  5. What is the Net Present Value of the project?
  6. What is the Internal Rate of Return of the project?
  7. Should the project be accepted? Why or why not?
  8. Discuss factors XYZ Corporation should consider if it were to lease the plant and equipment versus buying.



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