Question

FDC has decided to offer Unicorn Cookies.  We paid, a non-refundable, $120,000 for a marketing survey to help us understand food trends prior to settling in on Unicorn as the next new cookie option. FDC thinks that the new cookie will generate $300,000 in incremental sales per year. Fixed costs will be $125,000 per year, and variable costs will be approximately 30% of sales (lots of food coloring).  The capital investment in the equipment needed to produce the new cookies will cost $200,000 and will be depreciated in a straight-line manner for the 4 years of the cookie’s life (if you think unicorn will really last that long, I seriously hope it is already over). Assume no salvage value Net working capital will not be affected by this project (you’re welcome). The firm has an average tax rate of 15% and a marginal tax rate of 21%.  The required rate of return on projects with similar risk is 9%.   

What if fixed costs decreased by 10%, And, now we have working capital to think about- working capital goes up by $10k (we need to increase working capital- purchasing additional supplies, etc. to start up the new investment) in time zero and Year 1 and then, as we ramp down, working capital decreases in years 3&4 also by 10k per year.

                                                                                    

		Time ZERO	Year 1	Year 2	Year 3	Year 4
Cash Flow from Capital Investment
Changes in Working Capital
Cash Flow from Changes in Working Capital
Cash Flow from Ongoing Operations Annual Components:
Revenue
Fixed Expenses
Variable Expenses
Total Expenses
Total Cash Flow from Ongoing Operations
Depreciation
Taxes
After Tax Profit
Operating Cash Flow
Please evaluate the cash flows for the project and calculate the NPV
Discount rate

Total NPV calculation______________________

What’s the answer at discount rate of 5% (can you do this in less than 5 minutes?)

Answer 1

Depreciation computation
Year	0	1	2	3	4
Opening value	200,000.00	200,000.00	150,000.00	100,000.00	50,000.00
Depreciation	-	50,000.00	50,000.00	50,000.00	50,000.00
Closing value	200,000.00	150,000.00	100,000.00	50,000.00	-
Year	0	1	2	3	4
Cashflows from capital investment	(200,000.00)
Changes in working capital		(10,000.00)	(10,000.00)	10,000.00	10,000.00
Cashflow from changes in working capital		(10,000.00)	(10,000.00)	10,000.00	10,000.00
Cashflow from ongoing operations
Annual components :
Revenue		300,000.00	300,000.00	300,000.00	300,000.00
Fixed expenses (decreased by 10%)		(112,500.00)	(112,500.00)	(112,500.00)	(112,500.00)
Variable costs (30% of sales)		(90,000.00)	(90,000.00)	(90,000.00)	(90,000.00)
Total expenses		(202,500.00)	(202,500.00)	(202,500.00)	(202,500.00)
Total cash from ongoing operations		97,500.00	97,500.00	97,500.00	97,500.00
Depreciation		(50,000.00)	(50,000.00)	(50,000.00)	(50,000.00)
Before taxes income		47,500.00	47,500.00	47,500.00	47,500.00
Tax @ 21%		(9,975.00)	(9,975.00)	(9,975.00)	(9,975.00)
After tax income		37,525.00	37,525.00	37,525.00	37,525.00
Add : Depreciation		50,000.00	50,000.00	50,000.00	50,000.00
Operating cashflows		87,525.00	87,525.00	87,525.00	87,525.00
Total cashflows (investment + workign capital + Operations)	(200,000.00)	77,525.00	77,525.00	97,525.00	97,525.00
PV factor @ 9%	1.0000	0.9174	0.8417	0.7722	0.7084
PV of cashflows	(200,000.00)	71,123.85	65,251.24	75,307.19	69,089.17
NPV	80,771.46
Year	0	1	2	3	4
Cashflows from capital investment	(200,000.00)
Changes in working capital		(10,000.00)	(10,000.00)	10,000.00	10,000.00
Cashflow from changes in working capital		(10,000.00)	(10,000.00)	10,000.00	10,000.00
Cashflow from ongoing operations
Annual components :
Revenue		300,000.00	300,000.00	300,000.00	300,000.00
Fixed expenses (decreased by 10%)		(112,500.00)	(112,500.00)	(112,500.00)	(112,500.00)
Variable costs (30% of sales)		(90,000.00)	(90,000.00)	(90,000.00)	(90,000.00)
Total expenses		(202,500.00)	(202,500.00)	(202,500.00)	(202,500.00)
Total cash from ongoing operations		97,500.00	97,500.00	97,500.00	97,500.00
Depreciation		(50,000.00)	(50,000.00)	(50,000.00)	(50,000.00)
Before taxes income		47,500.00	47,500.00	47,500.00	47,500.00
Tax @ 21%		(9,975.00)	(9,975.00)	(9,975.00)	(9,975.00)
After tax income		37,525.00	37,525.00	37,525.00	37,525.00
Add : Depreciation		50,000.00	50,000.00	50,000.00	50,000.00
Operating cashflows		87,525.00	87,525.00	87,525.00	87,525.00
Total cashflows (investment + workign capital + Operations)	(200,000.00)	77,525.00	77,525.00	97,525.00	97,525.00
PV factor @ 5%	1.0000	0.9524	0.9070	0.8638	0.8227
PV of cashflows	(200,000.00)	73,833.33	70,317.46	84,245.76	80,234.06
NPV	108,630.61
Notes
1. Non refundable marketing survey cost of $120000 is not considered in the cashflow assessment as it is a sunk cost irrespective of whether the project is taken or not.
2. Marginal tax rate of 21% is considered (not average tax rate of 15%) as capital budgeting decision for this project would result in marginal increase in profit whereby average tax rate would not work with this.