Question

Your company produces candy and considers introducing a new flavor. A year ago, the company spent $19,300 on a marketing survey to learn about consumer interest in this flavor. If this new type of a candy is produced and offered for sale, the estimated revenue in Year 1 is $450,000. Sales are forecasted to grow at a rate of 4% per year. Incremental variable costs are expected to be 60% of incremental revenues. The net working capital in Year 0 is expected to be $81,000 with a full recovery at the end of the project. This project requires an immediate investment of $368,000 in equipment. The equipment is to be depreciated over 10 years on a straight-line basis to zero value. The new candy flavor will be discontinued in 5 years, and the project will end. At the end of this project, the equipment will be sold for $174,000. The tax rate is 35%, and the required rate of return is 16%. Based on the NPV and IRR investment criteria, should your company introduce a new candy flavor?

1) Should the cost of a marketing survey be included in your decision? Why or why not? (5 points)

2) Calculate the operating cash flow (OCF) for each year of the project. Show each item that goes into the OCF on its own row. (13 points)

3) Calculate the Initial Investment of the project. (5 points)

4) Calculate the Terminal cash flow of the project. (5 points) 5) Show full recovery in the Investment in Net Working Capital. (5 points)

6) Calculate the Cash Flow from Assets for each year of the project. (5 points)

7) Calculate the project’s NPV

a. State whether you should introduce a new candy flavor based on NPV. Explain why. (2 points)

8) Calculate the project’s IRR

a. Based on IRR, should you introduce a new candy flavor? Explain why. \

Answer 1

L L M N O Should the cost of a marketing survey be included in your decision? No, Marketking survey should not be included because it's a sunk cost, it won't impact the decision making. Year -0 Year - 1 Year - 2 Year - 3 $ 1,29,880.00 $ 1,34,560.00 $ 1,39,427.20 Year -4 Year - 5 $ 1,44,489.09 $ 1,49,753.45 Required Formula The operating cash flow (OCF) for each year =F23+F24 of the project? The Initial Investment of the project. =E29+E30 The Terminal cash flow of the project. =J10 the Cash Flow from Assets for each year of the project. =E25+E27+E28+E29 $ 4,49,000.00 4 $ 2,58,500.00 6 $-4,49,000.00 $ 1,29,880.00 $ 1,34,560.00 $ 1,39,427.20 $ 1,44,489.09 $ 4,08,253.45 7 Calculate the project's NPV 7a You should introduce based on NPV? 8 Calculate the project's IRR 8a You should introduce based on IRR ? =NPV(M21,F31:31)+E31 $1,26,465.44 Yes, you should introduce new flavour based on NPV because NPV is positive I=IRR(E31:31) 25.49% Yes, you should introduce new flavour based on IRR because IRR is higher than the required return Year 0 $ - Formula =M15 =-F16*$M17 =$M$18 =F16+F17+F18 Calculation of Operating Cash Flow Revenues Variable Cost Depreciation Earning Before Interest and Taxes Interest Earning Before Taxes Taxes Operating Profit AT Depreciation Operating Cash Flow Year 1 Year 2 Year 3 Year 4 Year 5 $ 4,50,000.00 $ 4,68,000.00 $ 4,86,720.00 $ 5,06,188.80 $ 5,26,436.35 $-2,70,000.00 $ -2,80,800.00 $-2,92,032.00 $-3,03,713.28 $-3,15,861.81 $ -36,800.00 $ -36,800.00 $ -36,800.00 $ -36,800.00 $ -36,800.00 $ 1,43,200.00 $ 1,50,400.00 $ 1,57,888.00 $ 1,65,675.52 $ 1,73,774.54 $ - $ $ 1,43,200.00 $ 1,50,400.00 $ 1,57,888.00 $ 1,65,675.52 $ 1,73,774.54 r$ 50,120.00 $ -52,640.00 $ 55,260.80 $ -57,986.43 $ -60,821.09 $ 93,080.00 $ 97,760.00 $ 1,02,627.20 $ 1,07,689.09 $ 1,12,953.45 $ 36,800.00 $ 36,800.00 $ 36,800.00 $ 36,800.00 $ 36,800.00 $ 1,29,880.00 $ 1,34,560.00 $ 1,39,427.20 $ 1,44,489.09 $ 1,49,753.45 Sale Price Increase in Sales Yearly Unit Cost Depriciation Tax Rate Years Rate of Return Salvage Value $4,50,000.00 Given in Question I 4.00% Given in Question 60.00% Given in Question $ -36,800.00 Given in Question 35.00% Given in Question 3.00 Given in Question 16.00% Given in Question $1,74,000.00 Given in Question =F19+F20 =-F21*$M$19 =F21+F22 --F18 -F23+F24 - - - - $ $ Initial Outlay Cost Increase in Net Working Capital Terminal Cashflow Given in Question Given in Question =J10 $-3,68,000.00 $ $ -81,000.00 $ $ - $ - - - $ $ $ . - Calculation of Terminal Cash Flow Salvage Value Accumulated Depreciation Book Value of Equipement Loss on Sale of Equipment Tax Salvage Value after Tax Net Working Capital Returns $1,74,000.00 Given in Question ($1,84,000.00) =SUM(F18:18) $1,84,000.00 --E27+M26 $ 10,000.00 =M27-M25 $ 3,500.00 =M28*M19 $1,77,500.00 =M25+M29 $ 81,000.00 |--E28 $ 2,58,500.00 Net Annual Cash Flow =E25+E27+E28+E29 $-4,49,000.00 $ 1,29,880.00 $ 1,34,560.00 $ 1,39,427.20 $ 1,44,489.09 $ 4,08,253.45