Question

BAREBELLS Protein Bars, the best balance of taste, low sugar and fat content, minimal calories and high protein content. Antah Pusaka Berhad is considering a proposal to manufacture BAREBELLS Protein Bars in Malaysia. The project requires use of an existing storehouse, which Antah acquired four years ago for RM1,240,000. and which it currently rents out for RM171,120. Rental rates are not expected to change going forward. In addition to using the storehouse, the project requires an upfront investment into Portioning & Cutting Equipment (CS-RS) of RM1,860,000. The CS-RS is using straight-line depreciation method for over the next 10 years. Antah expects to terminate the project at the end of eight years and to sell the machines and equipment for RM608,840. The project requires an initial investment into net working capital equal to 8% of predicted first- year sales. Subsequently, net working capital is 10% of the predicted sales over the following year. Sales of BAREBELLS Protein Bars are expected to be RM5,704,000 in the first year and to depreciation) are 75% of sales, and profits are taxed at 21%. (a) Calculate the free cash flows of the BAREBELLS Protein Bars project. (20 marks) (b) Compute the NPV of the BAREBELLS Protein Bars project, if the cost of capital is 13%. (10 marks) (TOTAL MARKS: 30 MARKS]

Answer 1

Solution 1) Assumption: The NWC is fully recovered at book value after 8 years.

Free Cash Flow (FCF) = EBIT*(1 – t) + Depreciation – CAPEX – Change in NWC (Net Working Capital)

a) FCF for Year 0:

In year 0, Capital Expenditure (CAPEX) on upfront investment into Portioning & Cutting Equipment (CS-RS ) = RM1,860,000 = RM1.86m

The project requires an initial investment into net working capital (NWC) equal to 8% of predicted first-year sales.

Predicted first-year sales = RM5,704,000 = RM5.704m

NWC for year 0 = 8%*5.704 = RM0.45632m

Using the above mentioned formula:

FCF in year 0 = EBIT*(1 – t) + Depreciation – CAPEX – Change in NWC

=0 + 0 - 1.86 - 0.45632 = -2.31632m = -2316320

b) FCF in year 1:

Total manufacturing costs and operating expenses (excluding depreciation) are 75% of sales

Profits are taxed at 21%.

Using straight-line depreciation method, Depreciation = Purchase Price/Useful Years

Depreciation = 1860000/10 = 186000

Sales	5704000
-Cost	-0.75*5704000
Gross Profit	1426000
- Lost Rent	-171120
- Depreciation	-186000
EBIT	1068880
- Tax (21%)	-224464.8
EBIT*(1-Tax%)	844415.2

Net Working Capital in Year 1 = 10%* 5.704m = 0.5704m

Change in Net Working Capital = NWC(at t = 1) - NWC(at t = 0)

Change in Net Working Capital = 0.5704m - 0.45632m = 0.11408m = 114080

Free Cash Flows for year 1 = EBIT*(1 – t) + Depreciation – CAPEX – Change in NWC

FCF (t = 1) = 844415.2 + 186000 - 0 - 114080 = 916335.2

c) FCF in years 2-7:

Sales	5704000
-Cost	-0.75*5704000
Gross Profit	1426000
- Lost Rent	-171120
- Depreciation	-186000
EBIT	1068880
- Tax (21%)	-224464.8
EBIT*(1-Tax%)	844415.2

Since, the workiing capital in each of these years is equal to 10% of the Sales and Sales is constant so, the working capital will be same in each year.   

Change in NWC = 0

FCF = EBIT*(1 – t) + Depreciation – CAPEX – Change in NWC

FCF (from t = 2 to 7) = 844415.2 + 186000 - 0 - 0 = 1030415.2

d) FCF for Year 8:

EBIT*(1-Tax%) = 844415.2

Capex = 0

The NWC (570400) is recovered at book value and hence its inflow rather than outflow.

Thus, Change in NWC = 570400

Machine Book Value at the end of Year 8 = 1860000 - 8*186000 = 372000

The machine is sold for = 608840

Profit on the machine = 608840 - 372000 = 236840

Tax on the profit of machine = 236840*21% = 49736.4

FCF = EBIT*(1 – t) + Depreciation – CAPEX – Change in NWC + Machine Selling Value - Tax paid on Profit of sale of machine

= 844415.2 + 186000 - 0 + 570400 + 608840 - 49736.4

= 2159919.80

Cash Flows

Year	0	1	2	3	4	5	6	7	8
FCF	-2316320	916335.2	1030415.20	1030415.20	1030415.20	1030415.20	1030415.20	1030415.20	2159919.80

Solution 2)

4 Year FCF Cost of Capital Net Present Value 0 1 2 3 -2316320.00 916335.2 1030415.20 1030415.20 1030415.20 1030415.20 1030415.20 1030415.20 2159918.80 13% 2952324.02 =NPV(Cost of Capital, Casf flow from t=1 to t=8) + Initial Outlay at t=0