Aunt Sally’s Foods, Inc. is a full line producer and distributor of ready to use
ID: 2711367 • Letter: A
Question
Aunt Sally’s Foods, Inc. is a full line producer and distributor of ready to use jarred food products such as gravies and sauces. Their products are well received in the marketplace competing with such brand names as Franco-American, Ragu and Heinz. Consider the following expansion opportunity for Aunt Sally’s Foods, Inc. Sally is considering expansion into a new line of all natural, cholesterol free, low sodium, low-calorie tomato sauces. Sally has paid $100,000 for a marketing study to assist in this and other potential valuations. The study indicates that the new product will have sales of $1,900,000 per year for each of the next 6 years. However, existing product line sales will be reduced by $200,000 per year. Manufacturing plant and equipment will cost $1,100,000 and will be depreciated on the straight-line method with a 10% market value (salvage value) at the end of 6 years. Annual fixed costs are projected at $160,000 per year and variable costs are projected at 55% of sales. Also, an initial working capital outlay of $175,000 will be required which will be recaptured at the end of the 6 years. Sally’s tax rate is 30% and the firm requires an 18% return. Based on the following criteria: 1) Net Present Value, and 2) Internal Rate of Return, should Sally undertake this project? (Please round to the nearest dollar on all calculations)
Explanation / Answer
1)CALCULATION OF NET PRESENT VALUE
PLANT AND EQUIPMENT COST=$11,00,000
SALVAGE VALUE OF PLANT AND EQUIPMENT=$11,00,000*10%=$1,10,000
DEPRECIATION=($11,00,000-$1,10,000)/6=$1,65,000
ANNUAL FIXED COST=$1,60,000
VARIABLE COSTS=55% OF SALES
TAX RATE=30%
REQUIRED RETURN=18%-30%=12.6%
INITIAL CASH OUTLAY:
PLANT AND EQUIPMENT=$11,00,000
MARKETING STUDY COST=$1,00,000
WORKING CAPITAL=$1,75,000
$13,75,000
CALCULATION OF NET CASH INFLOW
SALES OF NEW PRODUCT=$19,00,000
LESS:DECREASE IN SALES OF OLD PRODUCT=$2,00,000
LESS:FIXED COST=$1,60,000
LESS:VARIABLE COST ON NEW PRODUCT=$10,45,000
ADD:VARIABLE COST ON OLD PRODUCT REDUCED=$1,10,000
LESS :DEPRECIATION=$1,65,000
NET INCOME=$4,40,000
LESS TAX @30%=$1,32,000
INCOME AFTER TAX=$3,08,000
ADD:DEPRECIATION=$1,65,000
NET CASH INFLOW=$4,73,000
PRESENT VALUE OF FUTURE CASH INFLOWS=4,73,000PVIFA(12.6%,6)
=4,73,000*4.042
=$19,11,866
PRESENT VALUE OF SALVAGE VALUE OF PLANT AND EQUIPMENT AND WORKING CAPITAL
=$(1,10,000+1,75,000)PVIF(12.6%,6)
=$2,85,000*0.491
=$1,39,935
NET PRESENT VALUE=PRESENT VALUE OF FUTURE CASH INFLOWS+PRESENT VALUE OF SALVAGE AND WORKING CAPITAL -INITIAL CASH OUTLAY
=$19,11,866+$1,39,935-$13,75,000
=$6,76,801
INTERNAL RATE OF RETURN =18%-30%=12.6%
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