Question

Answer all parts since its one 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 $4,000k 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 L 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, CFo: 2019 2021 2023 2020 2022 Year 3 0 1 Period Investment Outlays at Time 0 CAPEX ANOWC Additional net operating working capital needed

Answer 1

CAPEX= cost of machines = $1,000,000 + $4,000,000 = $5,000,000

Change in NOWC = increase in inventory + increase in accounts payable = $600,000 + $100,000 = $700,000

Cost = $5,000,000

period	1	2	3	4
rate	0.33	0.45	0.15	0.07
depreciation	1650000	2250000	750000	350000

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 costs		$    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
tax = 40%		$                         -	$         700,000.00	$     1,300,000.00	$    1,460,000.00
After tax projected income		$ -1,650,000.00	$     1,050,000.00	$     1,950,000.00	$    2,190,000.00
Add back depreciation		$    1,650,000.00	$     2,250,000.00	$         750,000.00	$        350,000.00
EBIT(1-T)+Depreciation		0	$     3,300,000.00	$     2,700,000.00	$    2,540,000.00

Note- The company will $0 as tax in year 1 because it is experiencing a operating loss and thus will not pay any tax in that year.

Terminal cash flows at time =4

Salvage value	100000
Tax	40000
After tax salvage value	60000
Recovery of net operating working capital	700000

Note- The salvage value on the table in the question is $100 which is wrong as if you read the question, it tells us the salvage value is $100k = $100000.

Capex + change in NOWC

5700000

Year	2019	2020	2021	2022	2023
Operating cash flows over the project's life time
EBIT (1-T) + Depreciation		0	$     3,300,000.00	$     2,700,000.00	$    2,540,000.00
Terminal Cash flow at time =4
After tax salvage value + recovery of NOWC					$760000
Project free cash flows
	$5,700,000	0	$     3,300,000.00	$     2,700,000.00	$    3,300,000.00

For NPV and IRR

Year	Cash Flow
0	$ -5,700,000.00
1	0
2	$    3,300,000.00
3	$    2,700,000.00
4	$    3,300,000.00

To calculate the NPV, we need to first find the present value of all the cash flows discounted at WACC=10% and then all the present values are added. You may do this in excel as well by using the function of =NPV and then put rate = 10%, and then select the cash flows from year 1 to year 4, then press enter.

The sum of present values of the cash flows= $7,009,767.09

The NPV of the project = The sum of present values of the cash flows - Initial investment

= $7,009,767.09 - $5,700,000.00 = $1,309,767.09

For the IRR, just use the Excel function =IRR, then select all the cash flows from year 0 to year 4 and then press enter. You will get the IRR = 18.11%.

The project should be accepted as the NPV is positive and also the IRR is greater than the WACC.