Financial Analysis: Should the Company Accept the VR Smart Glasses Project?

The purpose of this general question is to incorporate the materials learned in this course together in an example. As a financial manager of the Orange Inc., which is in the business of manufacturing and selling smart glasses, you are tasked by the CEO to decide whether the company should undertake a new project that allows virtual reality to be implemented into the smart glasses (the CEO has found Mark Zuckerberg’s video on Meta very inspiring) or continue with the old iteration of smart glasses. The current manufacturing equipment is incapable of implementing the VR upgrade, posing an additional challenge if the firm is to undertake the project. The following information is provided from the estimates of the accounting team:
The project lasts for 5 years, after which a strategic change in how the firm operates is expected.
Accepting the project requires buying a new machine (capable of implementing VR) and selling your old machine (which will be obsolete).
The new machine costs $10 million and the delivery and installation costs by certified crew members requires $1 million.
The new machine can be salvaged for $3 million after 5 years.
The old machine can be sold today for $2 million, or it can be salvaged for $400 thousand after 5 years (if the firm decides not to undertake the project).
The new machine is significantly larger than the current one. Therefore, to install the new machine, a new land must be purchased today for $10 million. This land can be sold for $12 million in 5 years.
To operate the new machine, the project requires an immediate investment of $300 thousand in net working capital, which will increase by $60 thousand per year for each year of the project, and will be reclaimed at the end of the project.
Sale of the new smart glasses is estimated to be $8 million each year, starting from the first year.
If new smart glasses are introduced, people are less likely to purchase the last generation of smart glasses. The accounting team believes that the cannibalization of the old version of the smart glasses will be $1.2 million in the first year, and dropping by $200 thousand each year.
Due to the chip shortage, the accounting team expects that the cost of goods sold would be $3 million each year.
Encouraging people to purchase the VR smart glasses requires advertisement, which is estimated to cost $1.5 million each year, starting from the first year.
The new machine is more efficient than the old machine, which helps saving on electricity bills by $500 thousand each year.
The new machine belongs to the 25% CCA rate class.
The CEO has been sending you emails nonstop lately. In his last email, he told you that the company has invested $2 million on R&D for the new project in the previous two years, and would hate to see that money go to waste. He has also instructed you to keep the capital structure of the company intact, at 40% debt and 60% equity. To finance the project, you have asked the finance department to provide you with all the relevant information that can help you:
You can issue new shares for the company to be sold in the market for $68.5 each.
The beta of Orange Inc. equity is 1.6, The market portfolio is expected to have a 7% return.
The yield to maturity of 5-year government treasury bills is reported to be 2%.
The information on the company’s outstanding semi-annual bond:
Maturity: 6 years
Invoice price: $1080.5466.
Coupon rate: 5%.
Face value: $1000.
Finally, the tax rate is 35%.
It is a rainy weekend, and you have decided that it is finally time to prepare an answer for the CEO. You pour yourself a hot cup of coffee, open Excel (seriously, use Excel), and get to work. Should the company accept the new project?

Hint: To answer this question, you need to find the NPV of accepting the project (while being mindful of the sunk costs and opportunity costs). Using Excel is strongly recommended. For each of the years, input the proper values based on the information provided. Note the following points:
First you need to calculate the proper discount rate, which is WACC. Find the cost of equity and after-tax cost of debt to get WACC.
The salvage value for a machine can only be obtained if the machine is kept for 5 years.
For NWC, note that in the last year, there is a $60,000 cost as well as the return of all the NWC spent throughout the project.
CCA, similar to the salvage value, depends on which machine is kept. Depending on the choice for the project, the present value of CCA for the new machine will be gained, but the present value of CCA for the old machine will be lost. Use the PV of CCA formula for convenience. Both machines belong to the same asset class.
Note: The word “obsolete” does not mean that the salvage value or the price of the old machine is zero. Your default assumption should be that the cost-savings, generated revenues, side effects, and … are pre-tax unless the question says otherwise
Also, Capital gains, much like capital losses are subject to taxes. For any capital gain/loss, 50% of the gain/loss is subject to taxes.