Question

Frito Lay is considering a new line of potato chips. This will be a two year project.

a. Frito Lay paid $1,000,000 last year to a winning person who thought of the new line of potato chips.

b. New equipment for the factory line will cost $12,000,000 and depreciation is by the 5-year MACRS method. Purchase of the equipment will require an increase in net working capital of $600,000 at time 0 (which will be recaptured at the end of the project).

c. The new potato chips will generate an additional $6,000,000 in revenues in the first year and $4,000,000 in revenues in the second year.

d. In addition to the additional revenues outlined in c. The new potato chips will decrease existing chip line revenues by $2,000,000 the first year. There will not be any effect in the second year.

e. The new project is estimated to have expenses of $150,000 each year.

f. At the conclusion of the project, the equipment can be sold for $7,000,000.

g. The firm’s marginal tax rate is 20 percent, and the project’s cost of capital is 7 percent.

Accept of Reject?

Please answer questions in detail (show steps on finance calculator)

Thank you!

The following is the MACRS Depreciation Table: Year 3-year 5-year 7-year 33.33% 20.00% 14.29% 44.44% 32.00% 24.49% 14.82% 19.20% 17.49% 7.41% 11.52% 12.49% 11.52% 8.93% 5.76% 8.93% 8.93% 4.45%

Answer 1

OCF YEAR2 = total revenue - expenses

   = 4000000- 150000- 2000000 = 500000 - (dep) 384000 = 3340000 - tax 20% = 2672000+ (dep) 3840000=6512000

NPV =Initial investment (net cash outflow) - cash inflow

= 1,000,000 - 6,000,000(0.935)+4,000,000(0.8732)

= 1,000,000- 5,610,000- 3,492,800 =8,102,800

IRR = initial investment / after tax cash flow

= 1000000/ 7252240= 1.373