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.

Can you please answer all the 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%

sorry I accidentally posted the original information in white font.

Answer 1

Depreciation Expense in Year 1 = Cost of Machine * Rate of Depreciation in Y1

Cost of Machine = 12,000,000

Depreciation Rate = 20%

Depreciation Expense = 12,000,000 * 0.20 = 2,400,000

Depreciation Expense in Year 2 = Cost of Machine * Rate of Depreciation in Y2

Depreciation Expense = 12,000,000 * 0.33 = 3,840,000

Book Value of Assets at the end of 2nd year = 12,000,000 - 2,400,000 - 3,840,000 = 5,760,000

Equipment is sold for 7,000,000

After Tax Salvage = Salvage Value – Tax (Salvage Value – Book Value)

=7,000,000 - 0.20(7,000,000 - 5,760,000) = 6,752,000

Thanks