United Pigpen is considering a proposal to manufacture high-protein hog-feed.The project would make use of an existing warehouse, which is currently rented out to a neighboring firm. The next year’s rental charge on the warehouse in $100,000, and thereafter the rent is expected to grow in line with inflation at 2% a year. In addition to using the warehouse the proposal envisages an investment in plant and equipment of $1 million. However, Pigpen expects to terminate the project at the end of 10 years and to resell the plant and equipment in year 10 for $200,000. The project requires an initial investment in working capital of $300,000. Thereafter, working capital is forecast to be 10% of prior year sales. Year 1 sales of hog feed are expected to be $4 million, and thereafter sales are forecast to grow by 3% a year. Manufacturing costs are expected to be 90% of sales, and profits are subject to tax at 30%. The cost of capital is 12%.
Q1: Assume the investment in plant and equipment can be immediately expensed at year zero (rather than depreciated straight-line over 15 years). How does this change the project's NPV and effective tax rate? Provide a half page discussion explaining the change
Q2: A warehouse was built 5 years at the cost of $1 million, and is being depreciated for tax purposes straight-line over 40 years. Furthermore, yearly maintenance and issuance costs for the warehouse are $5000. Explain how these costs should be included in your NPV calculation. (Calculation is not required. One page maximum.)
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