Question

Amy Cola is considering launching a new soft drink product. The beverage will be sold in a variety of different flavors and will be marketed to young children. In evaluating the proposed project, the company has the following information: The company estimates that the project will last for 4 years. The company will need to purchase new machinery that has an up-front cost of $76 million (incurred at Year 0). The machinery will be fully depreciated on a 4-year straight-line basis with no salvage value. To gain more insight, Indiana had spent $3 million on marketing research costs. .Production of the new product will take place in a recently vacated facility that the company owns. It is currently empty and Indiana does not intend to lease the facility. The project will require a $18 million increase in net operating working capital (NOWC) at Year 0. After Year 0, there will be no changes in NOWC, until Year 4 when the project is completed, and the NOWC is fully recovered The company estimates that sales of the new drink will be $59 million each of the next four years. Operating costs (excluding depreciation) are expected to be $24 million each year The company's tax rate is 20%. The project's WACC is 15%. . . Based on the information above, the company has estimated the project's free cash flows as shown in the table below and concluded that it should not pursue this business opportunity as it is expected to generate a negative net present value (NPV).

Answer 1

Computation of Project cash Flow

Equipment Cost (0) $ 76

Marketing Research Cost (0)    $ 3

Working Capital   (0) $ 18 97

Calculation of Cash Flow

Year	1	2	3	4
Sales	59	59	59	59
Operating Cost	24	24	24	24
Depreciation & Amortise	19.75	19.75	19.75	19.75
Profit/Loss	15.25	15.25	15.25
Tax @ 20%	3.05	3.05	3.05	3.05
Profit/Loss after Tax	12.20	12.20	12.20	12.20
Add: Depreciation	19.75	19.75	19.75	19.75
Cash Inflow	31.95	31.95	31.95	31.95

Reaserch & Development Cost Amoritse Every Year

Computation of NPV

CIF of 4 Year =31.95 x PV@ 12% (15-20*15%)

= 31.95 x (0.893+.797+.712+.636)

= 31.95*3.038 = $ 97.06

But Cash Flow = $ 97 Total Profit $ .06

NPV is positive accept the Project

IRR: CO0 = Cash outflow of the time of Zero $ 97

COi = Cash inflow of the different point of time $ 31.95

N = Time 4

Therefore

$97 = $31.95/(1+r) Power 4

IRR = 12%

Payback Period = $ 97/31.95 = 3 years 1 month