Chill Mount Creamery manufactures a variety of Ice creams. The company is considering introducing a new product (Yugo cream). The company’s manager has been provided with the following information by their business analyst. ● The project has an anticipated economic life of 5 years. ●The Company plans to spend $1,300,000 on advertising campaign to boost sales. ●The Company’s interest expense each year will be $500,000. ● The Company is required to purchase a new machine to produce the new product. The machine’s initial cost is $5,500,000. The machine will be depreciated on a straight – line basis over 5 years. The Company anticipates that the machine will last for 10 years; the salvage value after 5 years is $500,000. ● Six months ago the Company also paid $300,000 to a firm to do research regarding new product. ● If the Company goes ahead with the new product, it will have an effect on the Company’s net operating capital. The forecasted net working capital will be $200,000 (at time zero) ● The new product is expected to generate sales revenue of $1,500,000, 2,500,000, 3,500,000, 4500,000 and 5,500,000 in year 1, 2, 3, 4 and 5 respectively. Each year the operating cost (not including depreciation) expected to equal 30 percent of sales revenue. ● In addition the Company expects with introduction of new product, sale of other ice cream increase by $500,000 after taxes each year. ● The Company’s overall WACC is 7.5 percent. However, the proposed project is riskier than the average project; the new project’s WACC is estimated to be 10 percent. ● The Company’s tax rate is 30 percent.
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