Question

Respond to the following scenario with your thoughts, ideas, and comments. Be substantive and clear, and use research to reinforce your ideas. Apix is considering coffee packaging as an additional diversification to its product line. Here's information regarding the coffee packaging project: • Initial investment outlay of $40 million, consisting of $35 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: $27 million per year for five years • Assume gross margin of 50% (exclusive of depreciation) • Depreciation: Straight-line for tax purposes • Selling, general, and administrative expenses: 10% of sales • Tax rate: 35% Assume a WACC of 10%. Should the coffee packaging project be accepted? Why or why not? Compute the project's IRR and NPV. In addition, answer the following questions: • Do you believe that there was sufficient financial information to make a solid decision on what to do? • Was there further financial information that you required that was not provided to you? • What financial figure do you believe was the determinant to your decision and why? • How would you be able to apply this particular financial information to other situations? • Discuss risk methodologies used in capital budgeting. Please submit your assignment

Answer 1

BC E F All amount in million $ 4 3 5 1 Working Note - Computation of NPV 2 Year 2 16 17 Cash Flows 11.94 11.94 18 Working Capital 11.94 11.94 11.94 19 11.94 11.94 11.94 0.9091 0.8264 0.7513 11.94 16.94 0.683 0.6209 20 Total Cash Flows 21 Present Value 22 Present Value of 23 Cash Flows 24 25 Cash Inflow 26 Cash Outflow 10.855 9.8678 8.9707 8.1552 10.518 48.367 40 27 28 NPV 8.3666 29

As the NPV is positive, the project should be accepted.

Working Note - Computation of Cash Flows Year - 1 2 Sales - 27 27 Gross Margin (50% of Sales) (A) 13.5 13.5 3 27 All amount in million $ 4 5 27 27 13.5 13.5 13.5 7 7 7 7 7 Depreciation (35/5) (B) Selling, General and Administrative Expenses (10% of Sales) (C) I 2.7 2.7 2.7 2.7 2.7 Net Margin before Tax, D = (A-B-C) 3.8 3.8 3.8 3.8 3.8 Tax Rate - 35% on D 1.33 1.33 1.33 1.33 1.33 Net Margin After Tax 2.47 2.47 2.47 2.47 2.47 Add : Depreciation 9.47 9.47 9.47 9.47 9.47 Cash Flows 11.94 11.94 11.94 11.94 11.94

All amount in 1 Working Note - Computation of IRR million $ 2 Year 1 2 3 4 5 20 Total Cash Flows 11.94 11.94 11.94 11.94 16.94 21 Present Value (20%) 0.8333 0.6944 0.5787 0.4823 0.4019 Present Value of 23 Cash Flows 9.95 8.2917 6.9097 5.7581 6.8078 25 Cash Inflow 26 Cash Outflow 37.717 40 21 28 NPV -2.283 30 Discount Rate 31 NPV 10% 8.3666 20% -2.283 33 As IRR is the rate at which the inflows is equal to the outlfows, so we would use intrapolition technique to derive the IRR 34 Discount Rate Value 10% 8.3666 0 20% -2.283 So, applying the basic math, we would get IRR to be 38 17.856%.

А Question B Answers 1 Yes, we believe that there was sufficient information to arrive at the decision as we have all the information, contractual cash flows and effective rate. 2. No, we don't think that we would require more information to arrive at the decision. 3 The major financial determinant was the cash flows, as this helped us to conclude the feasibility of the project. 4 The calculation of IRR and NPV would help us to conclude the viability of any project There are several methods which are used in capital budgeting, naming some of them are 1. Sensitivity Analysis - In this, risk is determined by keeping others values constants and one value variable. 2. Break Even Analysis - used to detemine the point where there would be no profit and no loss. 5 3. Scenario Analysis - It is an advanced version of sensitivity analysis, wherein more than one value is kept variable and others constant.