WBS Corp is a printing company that is considering an investment in a new textbook that
uses high-quality paper. The marketing team expects that the textbook will remain in print
for 5 years at which point its contents will become obsolete. Market research, which cost
the firm $120,000, indicates that 5,000 copies will be sold next year and the figures for the
subsequent years are 8,000, 12,000, 10,000, and 6,000. The textbook will be initially priced
at $20. The price is expected to rise by 2% a year whilst the inflation rate remains
unchanged at 5%. To print on high-quality paper, the company needs a new machine that
costs $100,000. The machine depreciates by 25% of its value per year. The machine is
expected to be sold for $30,000 at the end of the project. The machine will operate in a
vacant warehouse owned by the firm that can be sold for $150,000 after taxes. The
incremental corporate tax for this project is 28%. A single copy of the textbook will cost
$10 to print in the first year. The price of high-quality paper is expected to grow 10% per
year, and the firm expects that the costs of production will grow in parallel. To run this
project, the firm needs an immediate amount of $10,000 in cash and inventory. Additional
working capital of $6,320 and $8,650 are required at the end of year 2 and year 3,
respectively. The working capital goes down to $21,220 at the end of year 4 and will be
completely recovered when the project ends.
1. Estimate the projectʼs free cash flows.
2. Should the company proceed with the investment if its cost of capital is 10%?
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