Sugar Land Company is considering adding a new line to its product mix, and the

Question

Sugar Land Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by a MBA student. The production line would be set up in unused space (Market Value Zero) in Sugar Land’ main plant. Total cost of the machine is $240,000. The machinery has an economic life of 4 years, and MACRS will be used for depreciation. The machine will have a salvage value of $25,000 after 4 years.

The new line will generate Sales of 1,250 units per year for 4 years and the variable cost per unit is $100 in the first year. Each unit can be sold for $200 in the first year. The sales price and variable cost are expected to increase by 3% per year due to inflation. Further, to handle the new line, the firm’s net working capital would have to increase by $30,000 at time zero (No additional NWC is needed in years 2, 3 and the NWC will be recouped at the end of year 4). The firm’s tax rate is 40% and its weighted average cost of capital is 10%.

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What are the annual depreciation expenses for years 1 through 4? (10 P0ints)

Year 1

Year 2

Year 3

Year4

Depreciation

Calculate the annual sales revenues and variable costs (Don’t include depreciation in your cost estimation), for years 1 through 4. (15 points)

Year 1

Year 2

Year 3

Year4

$ Sales

$ Variable costs

Estimate annual (Year 1 through 4) operating cash flows (25 Points)

Year 1

Year 2

Year 3

Year4

Sales

OCF

Estimate the after tax salvage cash flow (5 points)

Estimate the net cash flow of this project (25 points)

Year zero

Year 1

Year 2

Year 3

Year4

CF of the project

Estimate the NPV, IRR, MIRR, and profitability Index of the project. (20 points)

NPV =

IRR =

MIRR =

PI

Year 1

Year 2

Year 3

Year4

Depreciation

Explanation / Answer

1. Annual depreciation calculation

2. Annual Sales and Variable Costs

3. Annual Operating Cash Flows

4. After Tax salvage value= $25000*(1-0.4) = $15000

5. Net Cash flow of the project year wise

6. Calculation Of NPV

NPV = 97269.818+99109.09+70462.13+91570.3333-270000 = +$ 88411.38

Now IRR by interpolation Technique:

NPV @ 25%:

NPV= 85597.44+76750.08+48017.97+54914.304-270000= -$ 4720.2

Now NPV @23%:

NPV = 86989.268+79266.31+50398.6+58574.0279-270000 = +$5228.21

IRR= Lower rate + NPV(L)/NPV(L)-NPV(H) * )Higher rate- Lower rate)

IRR= 23% + 5228.31/5228.31-(-4720.2) * (25-23) = 24.05%

Profitability Index: Present Value of Cash Inflows / Cash Outlay =

97629.818+99109.09+70462.13+91570.33 / 270000 =358411.4/270000 = 1.32745

PARTICULARS YEAR 1 YEAR 2 YEAR 3 YEAR 4 MACRS 33.33% 44.45% 14.81% 7.41% DEPRECIATION $ 79992 106680 35544 17784

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