Recognizing cash flows for capital investment projects, NPV.
City Manufacturing manufactures over 20,000 different products made from metal, including building materials, tools, and furniture parts. The manager of the furniture parts division has proposed that his division expand into bicycle parts as well. The furniture parts division currently generates cash revenues of $$\$ 5,300,000$$ and incurs cash costs of $$\$ 3,750,000$$, with an investment in assets of $$\$ 12,270,000$$. One-fifth of the cash costs are direct labor.
The manager estimates that the expansion of the business will require an investment in working capital of $$\$ 70,000$$. Because the company already has a facility, there would be no additional rent or purchase costs for a building, but the project would generate an additional $$\$ 300,000$$ in annual cash overhead. Moreover, the manager expects annual materials cash costs for bicycle parts to be $$\$ 1,650,000$$, and labor for the bicycle parts to be about the same as the labor cash costs for fumiture parts.
The controller of City, working with various managers, estimates that the expansion would require the purchase of equipment with a $$\$ 2,430,000$$ cost and an expected disposal value of $$\$ 450,000$$ at the end of its 6 -year useful life. Depreciation would occur on a straight-line basis.
The CFO of City determines the firm's cost of capital as $12 \%$. The CFO's salary is $$\$ 200,000$$ per year. Adding another division will not change that. The CEO asks for a report on expected revenues for the project, and is told by the marketing department that it might be able to achieve cash revenues of $$\$ 3,480,000$$ annually from bicycle parts. City Manufacturing has a tax rate of $40 \%$.