The Leventhal banking company is thinking of expending their operations into a n
ID: 2649797 • Letter: T
Question
The Leventhal banking company is thinking of expending their operations into a new line of pastries. the form expects to sell $350,000 of the new product in the first year and $500,000 each year thereafter. Direct costs including labor and materials will be 60% of sales. Indirect incremental costs are estimated at $400,000 a year. The project will require several new ovens which will cost a total of $500,000 and be depreciated straight line over five years. The current plan is underutilized, so space is available that cannot otherwise be sold or rented. The firm's marginal tax rate is 35% and cost of capital is 12%. Asssume revenue is collected immidiately and inventory is bought and paid for every day, so no additioanl working capital is required.
a. Prepare a statement showing the incremental cash flows for this project over an eight year period. (structure as a new venture)
b. Calculate payback period, NPV, PI
C. If the space to be used could otherwise be rented for 30k a year how would you put that fact into the calculation? Would the project be acceptable in that case?
Explanation / Answer
a. Prepare a statement showing the incremental cash flows for this project over an eight year period. (structure as a new venture)
Solution-
CASH FLOWS ($000)
0
1
2-5
6-8
Ovens
($500)
Revenue
$350
$500
$500
Direct Cost
(210)
(300)
(300)
Indirect Cost
(40)
(40)
(40)
Depreciation
(100)
(100)
--------
EBT Contribution
$0
$60
$160
Tax
--------
($21)
($56)
EAT Contribution
$0
$39
$104
Add Back Depreciation
$100
$100
-------
NCF
($500)
$100
$139
$104
b. Calculate payback period, NPV, PI
Solution-
Year
NCF
Cum CF
0
($500)
($500)
1
$100
($400)
2
$139
($261)
3
$139
($122)
4
$139
$17
Pay Back Period = 3.9 yrs
CF0 = -500
CF1 = 100
CF2-5 = 139
CF6-8 = 104
I = 12
Shift NPV = 107.98
Shift IRR = 18.03%
C. If the space to be used could otherwise be rented for 30k a year how would you put that fact into the calculation? Would the project be acceptable in that case?
Solution-
It would add a $30,000 per year pre-tax opportunity cost to the analysis.
The after-tax effect= $30,000*.65 = $19,500
The impact on the analysis would be to reduce the NPV by the present value of an 8-year annuity of this amount.
PVA = $19.5 [PVFA12,8]
PVA = $19.5 (4.9676)
PVA = $97
Then,
Revised NPV = Old NPV - $97
Revised NPV = $108 - $97
Revised NPV = $11
So, The project would be marginal acceptable under this condition.
CASH FLOWS ($000)
0
1
2-5
6-8
Ovens
($500)
Revenue
$350
$500
$500
Direct Cost
(210)
(300)
(300)
Indirect Cost
(40)
(40)
(40)
Depreciation
(100)
(100)
--------
EBT Contribution
$0
$60
$160
Tax
--------
($21)
($56)
EAT Contribution
$0
$39
$104
Add Back Depreciation
$100
$100
-------
NCF
($500)
$100
$139
$104
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.