Rockafeller Music Company
Rockafeller Music Company
The Rockafeller Music Company is considering expanding its production line to satisfy the demand for more CDs. The company has commissioned consultant studies for the expansion, spending $200,000 for these studies. The results of the studies indicate that the firm must spend $1 million on a new building and $500,000 on production equipment. The consultants' report predicts that the company can increase its revenues by $400,000 each year, while incurring an increase of $160,000 in expenses. The consultants expect rivals to step up production within five years, reducing benefits from the expansion to Rockafeller after five years. Therefore, a five-year time horizon is assumed for this expansion project. The expansion would require that the company increase it currents assets by $100,000 initially, but these asset accounts will be returned to previous levels at the end of the project.
Assume that the building is depreciated using straight-line over a twenty-year period and that it can be sold at the end of five years for $800,000. Further assume that the equipment is depreciated using straight-line over a ten-year period and that it can be sold at the end of five years for $150,000. The marginal tax rate of Rockafeller is 40%. The cost of capital for this project is 10%.
Should Rockafeller invest in this project? Explain.
| Item | 0 | 1 | 2 | 3 | 4 | 5 |
| Buy and sell the building | ||||||
| Buy and sell the equipment | ||||||
| Tax on the sale of the building | ||||||
| Tax on the sale of the equipment | ||||||
| Change in working capital | ||||||
| Acquisition and disposiiton cash flows | ||||||
| Change in revenues | ||||||
| Change in expenses | ||||||
| Change in depreciation | ||||||
| Change in taxable income | ||||||
| Change in taxes | ||||||
| Change in income after taxes | ||||||
| Add: Change in depreciation | ||||||
| Change in operating cash flow | ||||||
| Change in net cash flow | ||||||
Internal rate of return =