question archive Cinnamon, a manufacturer of industrial freezers, has recently developed a new highly energy-efficient freezer, the HC
Cinnamon, a manufacturer of industrial freezers, has recently developed a new highly energy-efficient freezer, the HC
Subject:FinancePrice: Bought3
Cinnamon, a manufacturer of industrial freezers, has recently developed a new highly energy-efficient freezer, the HC. Market research has shown that demand for the HC may be high (4800 units per year) or low (4250 units per year). The probability of high demand is 40%. The firm is now considering whether or not to go ahead with a project to produce and sell the HC for a period of four years. Each HC will be sold for $1400. The variable production costs will be $900 per HC. Cinnamon already owns a factory that can be used for the HC project. If Cinnamon does not go ahead with the project the factory could be sold now for $0.7 million. The project would require machinery to be bought now at a cost of $4.3 million. At the end of four years the value of the machinery will be zero. For the purposes of tax, the firm can claim depreciation (capital allowances) on the machinery at 25% per year. Assume Cinnamon will have enough taxable capacity from other projects to take advantage of any additional tax breaks from the HC project. All cash flows are assumed to occur at the end of the year except for those that would occur now. Cinnamon's cost of capital is 16% and the tax rate is 40%. a) (10 points) If demand for the HC is high, what is the net present value (NPV) of the project? What is the NPV if demand is low? b) (8 points) Calculate the probability of high demand at which the expected value of the NPV is zero. Should the firm undertake the project? Explain c) (7 points) Cinnamon used a market research firm to estimate the demand for the HC, at an agreed price of $100,000. Cinnamon has paid the market research firm $70,000 to date. By how much does this information change the expected NPV of the project? Explain.
