Question

Please first analyze cash flows for Project L. Then calculate NPV and IRR, and make your capital budgeting decision. To study the health-food market, Allied has done a market research in 2019. This market research costed Allied $10k. The research confirmed Allied's previous belief that the health-food industry has a huge potential and will be a highly profitable industry. Therefore, Allied is considering a new expansion project. Project L, which is a new health-food product that Allied is considering introducing to the health-food market. Below is the information Allied has collected for Project L: Allied currently owns a food processing equipment, with a market value of $1,000k, and will invest this equipment into Project L. In addition, Project L will require Allied to purchase $4,000 of equipment in 2019, i.e. t = 0. Inventory will increase by $600k and accounts payable will rise by $100k. All other working capital components will stay the same. Project I will last for 4 years. Allied forecasts the following sales: 2,000k units in 2020; 4,000k units in 2021; 4,000k units in 2022; and 4,000k units in 2023. Each unit will sell for $5. The fixed cost (except depreciation) of producing the product is $4,000k each year, and the variable cost of producing each unit will be $3 each year. Allied will use accelerated depreciation. The depreciation schedule will be given below. When the project is completed in 2023, Allied expects that it will be able to salvage the equipment for $100k (taxed as ordinary operating income) and that it will fully recover its initial investment into NOWC. The estimated tax rate is 40%. Based on the perceived risk, the project's WACC is estimated to be 10%. Please fill in the blank below, analyzing cash flows for Project L Enter all dollars (except for sales price and variable cost per unit) and unit sales in thousands. Initial investment, CF : 2019 2020 2021 2022 Year Period 1 2 3 Investment Outlays at Time = 0 2023 4 CAPEX ANOWC = Additional net operating working capital needed

Answer 1

Year		2019	2020	2021	2022	2023
Period		0	1	2	3	4
Cost of Market Research	$        10,000.00
Food Processing Equipment	$ 1,000,000.00
Other Equipment	$ 4,000,000.00
Inventory	$      600,000.00
Accounts Payable	$      100,000.00
Sales Units			2,000,000.00	4,000,000.00	4,000,000.00	4,000,000.00
Price of each unit			$                     5.00	$                     5.00	$                     5.00	$                     5.00
Fixed cost of Producing			$    4,000,000.00	$    4,000,000.00	$    4,000,000.00	$    4,000,000.00
Variable cost per unit			$                     3.00	$                     3.00	$                     3.00	$                     3.00
Salvage Value of Equipment						$        100,000.00
Tax Rate	40%
WACC	10%
Year		2019	2020	2021	2022	2023
Period		0	1	2	3	4
Investment Outlay at Time=0
CAPEX	$ 5,000,000.00
ANOWC= Additional net operating Capital Needed	$      700,000.00
		Accelerated Depriciation Period	1	2	3	4
		Rate	33%	45%	15%	7%
Cost (CAPEX)	$ 5,000,000.00		$    1,650,000.00	$    2,250,000.00	$        750,000.00	$        350,000.00
		Net Value	$    3,350,000.00	$    1,100,000.00	$        350,000.00	$                          -
Year		2019	2020	2021	2022	2023
Period		0	1	2	3	4
Unit Sales			2,000,000.00	4,000,000.00	4,000,000.00	4,000,000.00
Sales Price			$                     5.00	$                     5.00	$                     5.00	$                     5.00
Sales Revenue			$ 10,000,000.00	$ 20,000,000.00	$ 20,000,000.00	$ 20,000,000.00
Variable cost per unit			$                     3.00	$                     3.00	$                     3.00	$                     3.00
Variable cost			$    6,000,000.00	$ 12,000,000.00	$ 12,000,000.00	$ 12,000,000.00
Fixed Operating cost except Depreciation			$    4,000,000.00	$    4,000,000.00	$    4,000,000.00	$    4,000,000.00
Depreciation			$    1,650,000.00	$    2,250,000.00	$        750,000.00	$        350,000.00
Total Operating cost			$ 11,650,000.00	$ 18,250,000.00	$ 16,750,000.00	$ 16,350,000.00
EBIT			$ (1,650,000.00)	$    1,750,000.00	$    3,250,000.00	$    3,650,000.00
Taxes				$        700,000.00	$    1,300,000.00	$    1,460,000.00
After Tax Project Operating income			$ (1,650,000.00)	$    1,050,000.00	$    1,950,000.00	$    2,190,000.00
Add Back Depriciation			$    1,650,000.00	$    2,250,000.00	$        750,000.00	$        350,000.00
EBIT (1-T) + Depreciation			$                          -	$    3,300,000.00	$    2,700,000.00	$    2,540,000.00
Salvage Value						$        100,000.00
Tax on Salvage Value						$          40,000.00
After Tax Salvage Value						$          60,000.00
Recovery of net operating working capital						$        700,000.00
Year		2019	2020	2021	2022	2023
Period		0	1	2	3	4
Investment outlays at Time =0
CAPEX +ANOWC	$ 5,700,000.00
Operating Cash flows over the Project's Life (Time = 1-4)
EBIT(1-T)+Depreciation		$                          -	$                          -	$    3,300,000.00	$    2,700,000.00	$    2,540,000.00
Terminal Cash Flows at Time = 4
After-tax Salvage value+ Recovery of Net operating working capital						$        760,000.00
Project Free cash flows= [EBIT(1-T)+ DEP]-(CAPEX+ANOWC)
		$ (5,700,000.00)	$                          -	$    3,300,000.00	$    2,700,000.00	$    2,540,000.00
NPV		$790,676.87
IRR		15%

We should accept the Project since IRR is more than WACC and NPV is Positive