ABC Manufacturing Co. is considering implementing a new production process that would require an initial investment of $500,000 in specialized equipment. The equipment has an expected useful life of 5 years with no salvage value and would be depreciated using the straight-line method. The new process is expected to increase annual revenues by $200,000 and reduce annual operating expenses by $50,000. The company’s tax rate is 30%, and its required rate of return is 12%.
As the financial analyst for ABC Manufacturing Co., you have been asked to evaluate this investment opportunity using the Net Present Value (NPV) method. Additionally, the company wants to know the project’s Internal Rate of Return (IRR) and Payback Period.
Prepare a detailed analysis that includes:
- The annual after-tax cash flows for the project over its 5-year life.
- The calculation of the NPV using the 12% required rate of return.
- The calculation of the IRR.
- The calculation of the Payback Period.
- A brief explanation of what each of these metrics (NPV, IRR, and Payback Period) indicates about the project’s viability.
- Your recommendation on whether the company should proceed with the investment, considering all the calculated metrics.
In your analysis, clearly show all calculations and explain any assumptions you make. Also, discuss any limitations or potential risks associated with relying solely on these financial metrics for decision-making. How might qualitative factors influence the decision to implement this new production process?
Finally, if the company’s required rate of return were to increase to 15% due to changes in market conditions, how would this affect your analysis and recommendation? Briefly explain the impact of this change on the project’s viability.
