Question

Case study expanding into the fruit juice business with a new fresh lemon juice Allied Food Products is considering expanding into the fruit juice business ntly hired as assistant to the director of capital budgeting, and you product. Assume that you were recently hired as assistant to the director of must evaluate the new project. The lemon juice w e produced in an unused building adiacent to Allied's Fort Myers plant; Allied owns the building lant: Allied owns the building, which is fully de is fully depreciated. The required equipment would cost $200,000, plus an additional $40,000 for shipping and installation. In addition, in "pping and installation. In addition, inventories would rise by $25,000, while accounts payable would increase by $5,000. All of these costs would be incurred at t = 0. By a special ruling, the machinery could be depreciated under the MACRS system as 4- year property. The applicable depreciation rates are 15,35%, 15%, and 5%. The project is expected to operate for 4 years, at which time it will be terminated. The cash inflows are assumed to begin 1 year after the project is undertaken (t = 1), and to continue out to t = 4. At the end of the project's life (t = 4), the equipment is expected to have a salvage value of $25,000. Unit sales are expected to total 100.000 units per year, and the expected sales price is $2.00 per unit. Cash operating costs for the project total operating costs less depreciation) are expected to total 60% of dollar sales. Allied's tax rate is 21% and its WACC is 10%. Tentatively, the lemon juice project is assumed to be of equal risk to Allied's other assets. You have been asked to evaluate the project and to make a recommendation as to whether it should be accepted or rejected. To guide you in your analysis, your boss gave you the following set of tasks/questions: Table 1: Allied's Lemon Juice Project Linvestment Outleys Equipment cost Shipping and installation CAPEX Increase in inventory Increase in Accounts Payable ANOWC 100,000 x 2.00 $ 2.00 $ 2.00 $ 200,000 120,000 x I. Project Operating Cash Flows Unit sales Price per unit Total revenues Operating costs (wo depm) Depreciation Total costs EBIT (Operating income) Taxes on operating income EBIT (1-T) - After Tax operating income Add back depreciation EBIT (1-T). DEP 36,000 $ 12.000 228.000 204.000 44,000 x 14.280 $ X 34,760 36,000 $0 108.000 850 $ $ 12.000 65,720 1. Project Termination Cash Flows Salvage value Tax on salvage value After tax salvage value ANOWC - Recovery of NOWC Project Free Cash Flows EBIT(1-T). DEP-CAPEX - ANOWC $25,000 (5,250) 19.750 $20,000 106470 (260.000

Answer 1

	Years
	0	1	2	3	4
I. Investment Outlays
Equipment Cost	200,000
Shipping and Installation	40,000
CAPEX	240,000
Increase in Inventory	25,000
Increase in Accounts Payable	-5,000
Change in NWC	20,000
II. Project Operating Cash Flows
Unit Sales		100,000	100,000	100,000	100,000
Price per Unit		2	2	2	2
Total Revenues		200,000	200,000	200,000	200,000	Unit Sales x Price per unit
Operating Costs (w/o deprn)		120,000	120,000	120,000	120,000	Total Revenue/ 60%
Depreciation		96,750	75,250	32,250	10,750	(Total Capex - Salvage Value) x Depn rates
Total Costs		216,750	195,250	152,250	130,750
EBIT (Opearting Income)		-16,750	4,750	47,750	69,250	Total Revenue - Total Costs
Taxes on operating income		-3,518	998	10,028	14,543	EBIT x 21%
Profit after taxes		-13,233	3,753	37,723	54,708	EBIT - Taxes
Add back depreciation		96,750	75,250	32,250	10,750
Profit after taxes + Depn		83,518	79,003	69,973	65,458
III. Project Termination Cash Flows
Salvage Value					25,000
Tax on salvage value					5,250	Salvage Value x 21%
After Tax salvage value					19,750	Salvage Value - Tax
Recover of NWC					20,000
Project Free Cash Flows	-260,000	83,518	79,003	69,973	105,208	CAPEX+Change in NWC+Profit after taxes adding depren+After Tax Salv+NWC reco
PV Factor @ 10%	1.0000	0.9091	0.8264	0.7513	0.6830
Discounted Cash Flow	-260,000	75,925	65,291	52,571	71,858
NPV	5,646

Since NPV > 0, then project can be accepted