A juice manufacturer conducted a marketing study three years ago to determine th
ID: 2658348 • Letter: A
Question
A juice manufacturer conducted a marketing study three years ago to determine the consumers’ preferences for different type of juices including organic juices. This study was very extensive and detrimental in their decision to start a new organic juice division today. It cost them $1,000,000 to perform this study.
The company is considering introducing organic juices. The company will add a new assembly line in order to produce the organic juices separate from their existing assembly line for regular non-organic juices.
The project has an anticipated life of 4 years.
The new assembly line has a cost of $1,500,000. It will require $500,000 to customize it to the new specifications for organic juice production, and $100,000 for transportation and shipping to the company’s plant.
The new machine falls into 5-years MACRS category (20%, 32%, 19.2%, 11.52%, 11.52% and 5.76%).
The organic juice production will require inventories to increase by $1,000,000 at time 0; in addition, accounts payables and accruals will increase by $450,000 and $150,000 respectively.
The organic juice is expected to generate sales revenue of $700,000 million the first year. The revenue is expected to increase by $300,000 every year. Each year the operating costs (excluding depreciation) are expected to equal 50 percent of sales revenue.
In order to do this expansion, the company will borrow $3 million. The annual interest expense on this borrowing $400,000.
The organic juice is expected to decrease the company’s existing non-organic juice sale by $350,000 per year before tax basis.
The company can sell the new machine at the end of 4 years for $50,000 in the market. The company’s cost of capital is 12 percent. The company’s tax rate is 40 percent.
What is the initial investment CF0?
What is the CF1 to be used in NPV calculations?
What is the non-operating cash flow for year 4?
What is cash flow 4 to be used in NPV calculations?
What is the NPV of the project?
Explanation / Answer
Answer 1 Working Calculation of initial investment CF0 Depreciation calculation CF0 Year Depreciable value of assembly line Depreciation rate Depreciation Book value Cost of new assembly line -$1,500,000.00 1 2100000 20% 420000 1680000 Assembly line customization cost -$500,000.00 2 2100000 32% 672000 1008000 Transportation and shipping cost -$100,000.00 3 2100000 19.20% 403200 604800 Increase in Inventories -$1,000,000.00 4 2100000 11.52% 241920 362880 Increase in accounts payable $450,000.00 5 2100000 11.52% 241920 120960 Increase in accruals $150,000.00 6 2100000 5.76% 120960 0 Initial Investment -$2,500,000.00 Answer 2 Calculation of cash flow for Year 1 CF1 CF1 Sales revenue (less decrease in non organic juice sale ) 350000 Less : Operating cost 350000 less : Interest expense 400000 less : Depreciation 420000 Profit before tax -820000 Less : Tax @ 40% -328000 Profit after tax -492000 Add : Depreciation 420000 Cash flow For Year 1 -72000 Answer 3 Non operating cash flow for Year 4 Sale value of plant 50000 Less : Book value of plant at the end of 4th year 362880 Loss on sale -312880 Tax shield on Loss @ 40% 125152 Non operating cash flow for Year 4 (Sale value + Tax shield) 175152 Answer 4 Calculation of cash flow for Year 4 CF4 CF4 Sales revenue 1250000 Less : Operating cost 800000 less : Interest expense 400000 less : Depreciation 241920 Profit before tax -191920 Less : Tax @ 40% -76768 Profit after tax -115152 Add : Depreciation 241920 Add : Non operating cash flow 175152 Add : Recovery of net working capital 400000 Cash flow For Year 4 701920 Answer 5 Calculation of NPV Year Discount factor @ 12% Cash flow Present Value 0 1 -$2,500,000.00 -$2,500,000.00 1 0.892857143 -$72,000.00 -$64,285.71 2 0.797193878 $118,800.00 $94,706.63 3 0.711780248 $101,280.00 $72,089.10 4 0.635518078 $701,920.00 $446,082.85 NPV -$1,951,407.13 Working Calculation of cash flow for Year 2 & 3 CF2 CF3 Sales revenue (less decrease in non organic juice sale ) 650000 950000 Less : Operating cost 500000 650000 less : Interest expense 400000 400000 less : Depreciation 672000 403200 Profit before tax -922000 -503200 Less : Tax @ 40% -368800 -201280 Profit after tax -553200 -301920 Add : Depreciation 672000 403200 Cash flow For Year 1 118800 101280
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.