Question

Respond to the following scenario with your thoughts, ideas, and comments. Be substantive and clear, and use research to reinforce your ideas.

Over lunch, you and Mary meet to discuss next steps with the expansion project.

“Do we have everything we need on sales and costs?” you ask. ”It must be time to compute the net present value (NPV) and internal rate of return (IRR) of the Apix expansion project.”

“We have the data from James and Luke regarding projected sales and costs, respectively, for the food packaging project,” says Mary. “It is feasible to project that we will receive a tax break from this implementation. I have information from our audit firm that indicates that future depreciation methods for taxes will be straight-line; however, the corporate rates will be reduced to 35% as we assumed in our weighted average cost of capital (WACC) calculation.”

“That sounds good,” you say.

“Right," says Mary. "You can use a WACC of 10% for the computation of the NPV and comparison for IRR."

“I’ve got the information I need from Luke and James,” you say. "Does this look right to you? Here’s what they gave me,” you say, as you hand a sheet of paper to Mary.

“Let’s look at this now while we’re together,” she says.

The information you hand to Mary shows the following:

• Initial investment outlay of $30 million, consisting of $25 million for equipment and $5 million for net working capital (NWC) (plastic substrate and ink inventory); NWC recoverable in terminal year

• Project and equipment life: 5 years • Sales: $25 million per year for five years

• Assume gross margin of 60% (exclusive of depreciation)

• Depreciation: Straight-line for tax purposes

• Selling, general, and administrative expenses: 10% of sales

• Tax rate: 35%

You continue your conversation.

“It looks good,” says Mary. “Use this information from Luke and James to compute the cash flows for the project.”

“No problem,” you say.

“Then, compute NPV and IRR of the project using the Excel spreadsheet I sent earlier today,” says Mary.

“Use the IRR financial function for the computation of IRR.” “Okay,” you say. "I’ll submit my Excel file showing the computation of cash flows, NPV, and IRR by the end of week so you can look at it over the weekend.”

“Thanks,” says Mary. Complete the above worksheet for this assignment.

Answer 1

NPV = 10,538,625.96

IRR = 22.19%

Formula	Year (n)	0	1	2	3	4	5
	Initial depreciable investment (II)	25000000
	Sales (S)		25000000	25000000	25000000	25000000	25000000
	Gross margin (GM)		60%	60%	60%	60%	60%
GM*S	Gross profit (GP)		15000000	15000000	15000000	15000000	15000000
	SG&A		2500000	2500000	2500000	2500000	2500000
II/5	Depreciation (D)		5000000	5000000	5000000	5000000	5000000
GP - SG&A - D	EBIT		7500000	7500000	7500000	7500000	7500000
35%*EBIT	Tax @ 35%		2625000	2625000	2625000	2625000	2625000
EBIT-Tax	Net income (NI)		4875000	4875000	4875000	4875000	4875000
	Add: depreciation (D)		5000000	5000000	5000000	5000000	5000000
NI+D	Operating Cash Flow (OCF)		9875000	9875000	9875000	9875000	9875000
	Less: Increase in NWC	-5000000					5000000
OCF-Inc. in NWC	Free Cash Flow (FCF)	-30000000	9875000	9875000	9875000	9875000	14875000
1/(1+10%)^n	Discount factor @ 10%	1.000	0.909	0.826	0.751	0.683	0.621
FCF*Discount factor	PV of FCF	-30000000	8977272.73	8161157.02	7419233.66	6744757.87	9236204.68
Sum of all PVs	NPV	10,538,625.96
Using IRR function on FCFs	IRR	22.19%

Formulas used:

A В C D E F G Н 278 279 1 0 Year (n) Initial depreciable investment (II) 25000000 4 Formula 2 5 280 EG281 Sales (S) Gross margin (GM) Gross profit (GP) -E281 281 25000000 -D281 =F281 -F282 0.6 282 D282 -E282 -G282 283 GM*S =D282*D281 =E282 E281 -F282*F281 -G282*G281 H282*H281 - 10 % * F281 -E285 - 10 % *H281 -G285 SG&A 284 - 10 % * D281 - 10 % *E281 - 10 % *G281 285 /5 Depreciation (D) C280/5 -D283-D284-D285 -35%*D286 -F285 D285 G283-G284-G285 - 35% "G286 286 GP SG&A D -E283-E284- E285 - 35% "E286 -E286-E287 H283-H284-H285 EBIT F283-F284-F285 287 35%*EBIT - 35%H286 |Таx @ 35% 35%*F286 =F286-F287 288 EBIT-Tax Net income (NI) G286-G287 =D286-D287 H286-H287 Add: depreciation (D) Operating Cash Flow (OCF) -E285 -F285 H285 289 -D285 G285 290 NI+D -E288+E289 =F288+F289 G288+G289 H288+H289 D288+D289 -5000000 C290+C291-C280D290+D291-D280 -1/(1+10 % )^C279 1/(1+10 % ) ^D279 -C291 291 Less: Increase in NWC -E290+E291- E280 F290+F291-F280 -1/ (1+10 % )^E2791/(1+10%)AF279 -F293 F292 -G290+G291 -G280 H290+H291 -H280 Free Cash Flow (FCF) 292 OCF-Inc. in NWC 293 1/(1+10 % )An = 1/ ( 1+10 % ) AG279 |-1/(1+10 % ) AH279 Discount factor @ 10% PV of FCF D293*D292 294 FCF Discount factor C293*C292 =E293*E292 G293 *G292 H293 * H292 -SUM(C294:H294) IRR (C292: H292) 295 Sum of all PVs NPV 296 Using IRR function on FCFS IRR