Based on an organic food research study completed a year ago at a cost of $50,000, Vohra-Kam Company is considering whether to construct a new organic food production facility on a plot of land that it already owns. The land has a current market value of $1 million and was acquired at a cost of $400,000.
New machinery must be purchased at a cost of $200,000 and a new building must be erected at a cost of $500,000, both of which are eligible for 20% CCA on the declining balance and both of which would have a zero-salvage value at the end of 10 years from today. The land at the end of 10 years is expected to be sold for $1.2 million.
The new facility is expected to generate operating savings of $500,000 per year at the end of each year for the next 10 years.
The firm is subject to a 40% regular tax rate, and the capital gains are taxed at half this regular tax rate.
The cost of capital is 15% for the project.
a) What will be the company's initial investment in the project?
b) What will be the present value of the CCA-based tax savings resulting from the project?
c) What will be the present value of the expected operating savings as per the information above?
d) What will be the present value of the land's expected sale value at the end of 10 years from today?
e) What will be the project's NPV?
f) What can you say about the project's IRR, given your answer to Question e?