3. (A modified version of Problem 13-22 in p.470 of the textbook) NEW PROJECT AN
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3. (A modified version of Problem 13-22 in p.470 of the textbook) NEW PROJECT ANALYSIS You must analyze a potential new product—a caulking compound that Cory Materials’ R&D people developed for use in the residential construction industry. Cory’s marketing manager thinks the company can sell 115,000 tubes per year for 3 years at a price of $3.25 each, after which the product will be obsolete. The required equipment would cost $150,000, plus another $15,000 for shipping and installation. Current assets (receivables and inventories) would increase by $35,000, while current liabilities (accounts payable and accruals) would rise by $15,000. Variable costs would be 60% of sales revenues, fixed costs (exclusive of depreciation) would be $70,000 per year, and fixed assets would be depreciated using the straight line method. When production ceases after 3 years, the equipment is expected to have no market value. Cory’s tax rate is 40%, and it uses a 10% WACC for average-risk projects. Find the required Year 0 investment and the project’s annual net cash flows. Then calculate the project’s NPV, IRR, MIRR, and payback. Assume at this point that the project is of average risk. 3. (A modified version of Problem 13-22 in p.470 of the textbook) NEW PROJECT ANALYSIS You must analyze a potential new product—a caulking compound that Cory Materials’ R&D people developed for use in the residential construction industry. Cory’s marketing manager thinks the company can sell 115,000 tubes per year for 3 years at a price of $3.25 each, after which the product will be obsolete. The required equipment would cost $150,000, plus another $15,000 for shipping and installation. Current assets (receivables and inventories) would increase by $35,000, while current liabilities (accounts payable and accruals) would rise by $15,000. Variable costs would be 60% of sales revenues, fixed costs (exclusive of depreciation) would be $70,000 per year, and fixed assets would be depreciated using the straight line method. When production ceases after 3 years, the equipment is expected to have no market value. Cory’s tax rate is 40%, and it uses a 10% WACC for average-risk projects. Find the required Year 0 investment and the project’s annual net cash flows. Then calculate the project’s NPV, IRR, MIRR, and payback. Assume at this point that the project is of average risk. 3. (A modified version of Problem 13-22 in p.470 of the textbook) NEW PROJECT ANALYSIS You must analyze a potential new product—a caulking compound that Cory Materials’ R&D people developed for use in the residential construction industry. Cory’s marketing manager thinks the company can sell 115,000 tubes per year for 3 years at a price of $3.25 each, after which the product will be obsolete. The required equipment would cost $150,000, plus another $15,000 for shipping and installation. Current assets (receivables and inventories) would increase by $35,000, while current liabilities (accounts payable and accruals) would rise by $15,000. Variable costs would be 60% of sales revenues, fixed costs (exclusive of depreciation) would be $70,000 per year, and fixed assets would be depreciated using the straight line method. When production ceases after 3 years, the equipment is expected to have no market value. Cory’s tax rate is 40%, and it uses a 10% WACC for average-risk projects. Find the required Year 0 investment and the project’s annual net cash flows. Then calculate the project’s NPV, IRR, MIRR, and payback. Assume at this point that the project is of average risk.Explanation / Answer
Initial Upfront Investment =$150,000 + 15,000 =$165,000
Annual Depreciation using Straight Line =$165,000/3 =$55,000
Additional Working Capital Required =Change in Current Assets - Change in Current Liabilities
= 35,000 -15,000
= 20,000
a.) Initial Investment Required =$165,000 + $20,000 =$185,000
b.) Annual Revenue $ 373,750 [115,000 x 3.25 =$373,750]
Fixed Costs $ 70,000
Variable Costs $ 224,250 [0.60x373,750 =224,250]
Depreciation $ 55,000
EBIT $ 24,500
Annual Free Cash Flow = EBIT x (1-T) + Depreciation
= 24,500 x (1-0.40) + 55,000
= 24,500 x 0.60 + 55,000
= 14,700 + 55,000
= 69,700
c.) Assuming that the initial increase in working capital requriement will be unlocked towards the end of project,
Project NPV @ 10% = -185,000 + 69,700 x {(1-(1+0.10)-3)/0.10} + 20,000/(1+0.10)3
= -185,000 + 69,700 x 2.4868 + 15,026
= -185,000 + 173,334 +15,026
= 3,360
Thus, the project NPV is $3,360
d.) IRR is the rate at which the NPV =0
-185,000 + 69,700 x {(1-(1+IRR)-3)/IRR} + 20,000/(1+IRR)3 = 0
Using Trial and Error method to calculate IRR,
For IRR=0.05, LHS=22088
For IRR=0.10, LHS=3359
For IRR=0.11, LHS= -49
For IRR=0.1098 LHS=0
Hence, the Project IRR=10.98%
e.) MIRR = {FV of Positive Cash Flows/ -PV of Negative Cash Flows}1/3 - 1
= {(69,700x(1+0.10)2 + 69,700x(1+0.10) + 69,700 + 20,000) / -(-185,000) }1/3 -1
= {250,707/185,000}1/3 -1
= 1.1066 -1
= 0.1066
Hence, the MIRR is 10.66%
f.) Cumulative Cash Flows will be = -185,000 -115300 -45600 44100
Non-Discounted Payback period = 2 + 45600/(44100 + 45600) = 2+0.5083 =2.51 years
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