Sunshine Smoothies Company (SSC) manufactures and distributes smoothies. SSC is

Question

Sunshine Smoothies Company (SSC) manufactures and distributes smoothies. SSC is considering the development of a new line of high-protein energy smoothies. SSC's CFO has collected the following information regarding the proposed project, which is expected to last 3 years:

The project can be operated at the company's Charleston plant, which is currently vacant.

The project will require that the company spend $4 million today (t = 0) to purchase additional equipment. For tax purposes the equipment will be depreciated on a straight-line basis over 5 years. Thus, the firm's annual depreciation expense is $4,000,000/5 = $800,000. The company plans to use the equipment for all 3 years of the project. At t = 3 (which is the project's last year of operation), the equipment is expected to be sold for $1,200,000 before taxes.

The project will require an increase in net operating working capital of $730,000 at t = 0. The cost of the working capital will be fully recovered at t = 3 (which is the project's last year of operation).

Expected high-protein energy smoothie sales are as follows:

Year Sales

1 $2,200,000

2 7,750,000

3 3,500,000

The project's annual operating costs (excluding depreciation) are expected to be 60% of sales.

The company's tax rate is 40%.

The company is extremely profitable; so if any losses are incurred from the high-protein energy smoothie project they can be used to partially offset taxes paid on the company's other projects. (That is, assume that if there are any tax credits related to this project they can be used in the year they occur.)

The project has a WACC = 10.0%. What is the project's expected NPV and IRR? Round your answers to 2 decimal places. Do not round your intermediate calculations.

Explanation / Answer

Solution:

Year 0 Year 1 Year 2 Year 3 Initial Investment 4,000,000 Add: Net working Capital 730,000 Total Outflow 4,730,000 Sales          2,200,000          7,750,000          3,500,000 Less: annual operating costs          1,320,000          4,650,000          2,100,000 Less: Depreciation              800,000              800,000              800,000 net income before tax                80,000          2,300,000              600,000 Less: Tax expense - 40 %                32,000              920,000              240,000 Income after tax                48,000          1,380,000              360,000 Add: Depreciation              800,000              800,000              800,000 Add: terminal value net of tax          1,360,000 Add: Working capital              730,000 Annual cashflows 848,000 2,180,000 3,250,000 Present value of $ 1 @ 10 % 0.909 0.826 0.751 Present value of cashflows        770,909.09    1,801,652.89    2,441,773.10 Total present value of cashflows 5,014,335.09 NPV = Total present value of cashflows - Total outflows 284,335

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