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85,000

Production of the implants will require $1,500,000 in net working capital to start and additional net working capital investments each year equal to 20 percent of the projected sales increase for the following year. Total fixed costs are $750,000 per year, variable production costs are $210 per unit, and the units are priced at $330 each. The equipment needed to begin production has an installed cost of $14,000,000. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as seven-year MACRS property. In five years, this equipment can be sold for about 30 percent of its acquisition cost. AAI is in the 35 percent marginal tax bracket and has a required return on all its projects of 30 percent. Based on these preliminary project estimates, what is the NPV of the project? What is the IRR?

26. Calculating Required Savings A proposed cost-saving device has an installed cost of $540,000. The device will be used in a five-year project, but is classified as three-year MACRS property for tax purposes. The required initial net working capital investment is $40,000, the marginal tax rate is 35 percent, and the project discount rate is 12 percent. The device has an estimated Year 5 salvage value of $60,000. What level of pretax cost savings do we require for this project to be profitable?

27. Financial Break-Even Analysis To solve the bid price problem presented in the text, we set the project NPV equal to zero and found the required price using the definition of OCF. Thus the bid price represents a financial break-even level for the project. This type of analysis can be extended to many other types of problems. a. In Problem 19, assume that the price per carton is $11 and find the project

NPV. What does your answer tell you about your bid price? What do you know about the number of cartons you can sell and still break even? How about your level of costs?

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

IV. Capital Budgeting

10. Making Capital Investment Decisions

© The McGraw-Hill Companies, 2002

PART FOUR Capital Budgeting

Challenge

(continued)

Solve Problem 19 again with the price still at $11 but find the quantity of cartons per year that you can supply and still break even. Hint: It's less than 170,000.

Repeat (b) with a price of $11 and a quantity of 170,000 cartons per year, and find the highest level of fixed costs you could afford and still break even. Hint: It's more than $160,000.

Spreadsheet Templates 10-6, 10-7, 10-10, 10-14, 10-18, 10-21, 10-25

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

IV. Capital Budgeting

11. Project Analysis and Evaluation

© The McGraw-Hill Companies, 2002

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

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