Sample Capital Bugeting Problem:
A company is considering a project that requires an initial investment of $24M to build a new plant and purchase equipment. The investment will be depreciated as a MACRS 7-year class (see p. 21 in the text) asset. The new plant will be built on some of the company's land which has a current, after-tax market value of $4.3M. The company will produce units at a cost of $130 each and will sell them for $420 each. There are annual fixed costs of $0.5M. Unit sales are expected to be 150,000 each year for the next 6 years, at which time the project will be abandoned. At that time, the plant and equipment is expected to be worth $8M (before tax) and the land is expected to be worth $5.4M (after tax). To supplement the production process, the company will need to purchase $1M worth of inventory. That inventory will be depleted during the final year of the project. The company has $100M of debt outstanding with a yield-to-maturity of 8%, and has $150M of equity outstanding with a beta of 0.9. The expected market return is 13% and the risk-free rate is 5%. The company's marginal tax rate is 40%. Should the project be accepted?