The Following Data Have Been Collected by Capital Budgeting Analysts

question 86

Essay

The following data have been collected by capital budgeting analysts at Erica, Inc.concerning a new product line currently under consideration by management:
$\begin{array}{lrr} \text { Investment in machinery and equipment required to produce the product } &\$3,500,000\\ \text { Net increase in working capital associated with the new product. } &\\ \text {Assume that this investment will be recovered at the end of the project } &500,000\\ \text { Net cash inflow from operations for the expected life of the product line for: } &\\ \text { Year 1 } &550,000\\ \text { Yeat 2 } &900,000\\ \text { Year 3 } &1,400,000\\ \text {Year 4 } &1,800,000\\ \text {Salvage value of machinery and equipment at the end of the } &\\ \text {product line's life } &300,000\\ \text { Cost of capital } &10\%\\\end{array}$

(a.)Calculate the net present value of the proposed investment in the new product line.Ignore income taxes, and round all answers to the nearest $1.
(b.)What will the internal rate of return on this investment be relative to the cost of capital? Explain your answer.

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Definitions:

Peak

The highest point reached by a commodity or market price before a decline.

Recession

A period of temporary economic decline during which trade and industrial activity are reduced.

Purchasing Power

Purchasing power denotes the value of a currency expressed in terms of the amount of goods or services that one unit of money can buy.

Real Income

Income adjusted for inflation, reflecting the actual purchasing power of money received.