TexMex Food Company is considering a new salsa whose data are shown below. The e
ID: 2714696 • Letter: T
Question
TexMex Food Company is considering a new salsa whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no change in net operating working capital would be required. Revenues and other operating costs are expected to be constant over the project’s 3-year life. However, this project would compete with other TexMex products and would reduce their pretax annual cash flows. What is the project’s NPV? (Hint: Cash flows are constant in Years 1–3.) WACC 10.0% Pre-tax cash flow reduction for other products (cannibalization) $5,000 Investment cost (depreciable basis) $80,000 Straight-line depreciation rate 33.333% Annual sales revenues $67,500 Annual operating costs (excl. depreciation) $25,000 Tax rate 35.0% . show solution.
Explanation / Answer
Calculation of Present value of Cash infow:-
Revenue
(-) Operating costs
67500
25000
Profit before Depreciation & Tax (PBDT)
(-) Depreciation (80000 * 33.33%)
(-) Pre-tax cash flow reduction for other products
42500
26667 (approx)
5000
Profit Before Taxes (PBT)
(-) Tax @ 35%
10833
3792 (approx)
Profit after Tax
(+) Depreciation
7041
26667
Annual cash inflow for Year 1 - 3
33708
Cumulative Present value factors@10% for 3 Years
2.487 (approx)
Present value of cash inflow ( 33708 * 2.487)
83832
Present value of cash outflow = 80000
Project's NPV = Present value of cash inflow - Present value of cash outflow
= 83832 - 80000
= $3832
Conclusion:- Project's NPV = $3832.
Note:- Calculations in the questions are rounded-off.
Revenue
(-) Operating costs
67500
25000
Profit before Depreciation & Tax (PBDT)
(-) Depreciation (80000 * 33.33%)
(-) Pre-tax cash flow reduction for other products
42500
26667 (approx)
5000
Profit Before Taxes (PBT)
(-) Tax @ 35%
10833
3792 (approx)
Profit after Tax
(+) Depreciation
7041
26667
Annual cash inflow for Year 1 - 3
33708
Cumulative Present value factors@10% for 3 Years
2.487 (approx)
Present value of cash inflow ( 33708 * 2.487)
83832
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