(25 points) Movies, Inc. is considering a new 5-year project producing education
ID: 2785615 • Letter: #
Question
(25 points) Movies, Inc. is considering a new 5-year project producing educational movies for e project requires an investment in equipment of $2,600,000. The equipment will be fully epreciated using straight line depreciation over its 8 year accounting life. At the end of the project the children. The expects to be able to sell the equipment for $125,000. The firm expects to sell 775,000 videos each year over the life of the project. The retail price for each video will be $20.00, variable costs related to production are $12.00 per video. Additional fixed costs include $1,000,000 per year fot labor, S750,000 for rent and $500,000 for all other expenses. The project also requires an additional t in net working capital of $500,000. Working capital will remain at this level throughout the investmen life of theproject. The firm'smarginal tax rate s34% andtherequiredreturmonthisproject is 12%, your answer. why or why not?Clearly explain in equipment 2, 60o, 00 Por 12S,000 o end of ife video 20"Explanation / Answer
Cash flows over the life:
Cash in year 0: Equipment cost + working capital
= -2600000-500000 = -3100000
Cash flows from year 1 to 4:
= (Annual revenues - variable cost - fixed cost - depreciation)*(1-taxes) + depreciation
= (775000*20 - 775000*12 - 1000000-750000-500000 - (2600000/8))*(1-0.34) + (2600000/8)
= 2717500
Cash flow in year 5:
= (Annual revenues - variable cost - fixed cost - depreciation)*(1-taxes) + depreciation + salvage value + working capital
= (775000*20 - 775000*12 - 1000000-750000-500000 - (2600000/8))*(1-0.34) + (2600000/8) + 125000 + 500000
= 3342500
So,
NPV = -3100000 + 2717500/1.12 + 2717500/1.12^2 + 2717500/1.12^3 + 2717500/1.12^4 + 3342500/1.12^5
= 7050621.11
Since NPV is positive, the project should be chosen.
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