Reference no: EM133008496

Q-CURE Ltd is planning to invest in an energy-enhancing drink project that requires equipment with a purchase price of $90,000. The installation cost of $5,000 for the drink-producing equipment would be paid by the supplier. The transportation cost for the equipment would be $15,000. The machine will have an economic life of six years and would be depreciated at 14 percent straight line for the tax purpose. The salvage value of the equipment is estimated to be $15,000 at the end of the project life.

• Starting production with this machine requires an additional investment of $23,000 in inventory and $9,000 in accounts receivable. Whereas, there would be additional accounts payable of $15,000.

• In order to analyse the effectiveness of the drink to boost up energy, the management has spent $11,000 for clinical tests. The tests revealed that the drink would have some detrimental effects on the health for prolonged uses by some users. Despite the adverse outcomes of the tests, the management has decided to go for the production. Expected sales in the first year would be $95,000. Sales are expected to grow at 25% in each year until the 6th year. Costs have been estimated to be 40 percent of sales revenue. In addition, there would be an annual fixed overhead cost of $8,538.

• If the project is started, annual sales of the company's vitamin products will increase by $15,000 in the first year and that increased sales will further grow by 7 percent in each year until the 6th year. The cost of sale for the vitamin products is 60 percent. Whereas, the company's regular net earnings of $9,000 from the same production facility would be stopped due to the start of the project. This new project will increase the annual interest expense from $6,000 to $8,700.

• Applicable corporate tax rate would be 34 percent.

• The cost of capital is estimated to be either 11.31 percent or 17.00 percent. The management has targeted a discounted payback period of four years.

Problem 1: What would be your decision about this project at 11.31 and 17.00 percent costs of capital?