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Fort St. John's Drilling Co. is looking to develop a new alternative power project to address the rising energy costs that are currently threatening...

Fort St. John's Drilling Co. is looking to develop a new alternative power project to address the rising energy costs that are currently threatening the firm's viability.  The company has researched various alternatives and has decided that the best solution would involve the purchase of new equipment costing $5.0 million (CCA class 8), and a new building that would cost $2.0 million (CCA Class 1). During the investigation of alternatives, the company hired a lawyer to analyze all potential projects for a total cost of $750,000. The project chosen will also entail an investment in working capital of $1.0 million. The company's analysts forecast that the project will produce before tax cash flows of $4.5 million annually for the projects duration.  The useful life of the project is 20 years.  At the end of the useful life, the building and equipment can be sold for their undepreciated capital cost at the end of the 20th year. The corporate tax rate is 40% and the cost of capital is 12%.  Assume that other assets will remain in the asset classes following the sale of the equipment and building and that the UCC of each class will be positive. 


What would happen if the company's cost of capital increased to 15%, and the analysts had done a poor job forecasting the cash flows, and the real cash flows from the project before tax were $1.5 million? Would they still accept the project?

 

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