Sunshine Smoothies Company (SSC) manufactures and distributes smoothies. SSC is
ID: 2766371 • Letter: S
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 $3.5 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 $3,500,000/5 = $700,000. 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 $1,600,000 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:
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.
Year Sales 1 $2,000,000 2 7,550,000 3 3,400,000Explanation / Answer
Initial investment = Cost of additional equipment + Increase in net working capital = $3,500,000 + $730,000 = $4,230,000
Annual depreciation = $700,000
Depreciation charged till the end of project = $700,000 * 3 = $2,100,000
Book value of the equipment at the end of project (Year 3) = Cost of equipment – Depreciation charged = $3,500,000 - $2,100,000 = $1,400,000
Sale value of equipment = $1,600,000
Gain on sale of equipment = $1,600,000 - $1,400,000 = $200,000
Tax on gain on sale = $200,000 * 40% = $80,000
Net receipt on sale of equipment = Sale value of equipment – Tax payable on gain on sale of equipment = $200,000 - $80,000 = $120,000
Year
0
1
2
3
A.
Cost of equipment
-$ 3,500,000.00
Net working capital
-$ 730,000.00
Initial investment
-$ 4,230,000.00
B.
Sales
$ 2,000,000.00
$ 7,550,000.00
$ 3,400,000.00
Operating cost @ 60%
-$ 1,200,000.00
-$ 4,530,000.00
-$ 2,040,000.00
Depreciation
-$ 700,000.00
-$ 700,000.00
-$ 700,000.00
Income before taxes
$ 100,000.00
$ 2,320,000.00
$ 660,000.00
Taxes @ 40%
-$ 40,000.00
-$ 928,000.00
-$ 264,000.00
Income after taxes
$ 60,000.00
$ 1,392,000.00
$ 396,000.00
Add: Depreciation
$ 700,000.00
$ 700,000.00
$ 700,000.00
Operating cash flow
$ 760,000.00
$ 2,092,000.00
$ 1,096,000.00
C.
Release of net working capital
$ 730,000.00
Sale of equipment
$ 120,000.00
Terminal cash flow
$ 850,000.00
Free cash flow
-$ 4,230,000.00
$ 760,000.00
$ 2,092,000.00
$ 1,946,000.00
a.
Year
Cash flow
Present value @ 10%
Present value of cash flows
0
-$ 4,230,000.00
1
-$ 4,230,000.00
1
$ 760,000.00
0.9091
$ 690,916.00
2
$ 2,092,000.00
0.8264
$ 1,728,828.80
3
$ 1,946,000.00
0.7513
$ 1,462,029.80
Net present value
-$348,225.40
Hence net present value = -$348,225.40
b.
Let the IRR be r,
At IRR,
Initial investment = Present value of future cash flows
$4,230,000 = $760,000/(1+r) + $2,092,000/(1+r)2 + $1,946,000/(1+r)3
Solving above equation,
r = 0.05805
Hence IRR = 5.85%
Year
0
1
2
3
A.
Cost of equipment
-$ 3,500,000.00
Net working capital
-$ 730,000.00
Initial investment
-$ 4,230,000.00
B.
Sales
$ 2,000,000.00
$ 7,550,000.00
$ 3,400,000.00
Operating cost @ 60%
-$ 1,200,000.00
-$ 4,530,000.00
-$ 2,040,000.00
Depreciation
-$ 700,000.00
-$ 700,000.00
-$ 700,000.00
Income before taxes
$ 100,000.00
$ 2,320,000.00
$ 660,000.00
Taxes @ 40%
-$ 40,000.00
-$ 928,000.00
-$ 264,000.00
Income after taxes
$ 60,000.00
$ 1,392,000.00
$ 396,000.00
Add: Depreciation
$ 700,000.00
$ 700,000.00
$ 700,000.00
Operating cash flow
$ 760,000.00
$ 2,092,000.00
$ 1,096,000.00
C.
Release of net working capital
$ 730,000.00
Sale of equipment
$ 120,000.00
Terminal cash flow
$ 850,000.00
Free cash flow
-$ 4,230,000.00
$ 760,000.00
$ 2,092,000.00
$ 1,946,000.00
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.