Question

Burger King is planning to add a mango milkshake to its menu. The company tested the product in three major cities last year at a cost of $2 million and determined that there is considerable demand. At present, they only plan to sell the mango shakes for 5 years. Burger king plans to price this new flavor at $2 per shake and they anticipate selling 10 million mango shakes each year. Large quantities of mango trees will need to be purchased immediately at a total cost of $20 million. This will be a capital expense which Burger Kings will depreciate on a straight line basis to a value of zero over the next 5 years. Unfortunately, Burger King learned during the test market that the mango shakes will eat into the sales of their vanilla shakes. They only expect this happen during the first year though, when they expect to lose $4 million in sales of vanilla shakes from what they otherwise would have had. Both the vanilla and mango shakes have variable cost equal to 60% of their purchase price. The additional business from the new product will necessitate an injection of $1 million in net working capital immediately. Burger King expects that level of working capital to remain constant during the 5 years that the mango shakes are sold and then they expect to recover it at the end of the 5th year. Burger King’s stock is selling at $25 per share and it has a beta of 0.9. The risk free rate is 3% and the market risk premium 5.7%. The company has $240 million shares of common stock outstanding and debt (Bonds) with a face value of $800 million. All of its bonds will mature in 13 years are priced at 102, and have a coupon rate of 6.4%. Burger King’s marginal tax rate is 21%. Determine the free cash flows for this project and show them on the time line provided (in millions) below. Then calculate the WACC and the NPV. All cash flows should be discounted at the WACC.

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Please note above: number of bonds/shares outstanding is 240 million!!

Answer 1

Calculations of free cashflow
Cashinflow
	1st year	2-5 year
	Millions	Millions	Total
Sales	20	20
Variable Cost(0.6*sales)	12	12
R&D Cost	2	0
Loss in Vanilla	4	0
Depreciation(20/5)	4	4
Profit	-2	4
Tax 21%		0.84
Net income	-2	3.16
Dep	4	4
Free Cashflow	2	7.16
PV @ 5.61	0.947	3.311
PV of cashflow	1.894	23.704	25.598
Cashoutflow
	0
Initial investment	20
Working Capital	1
Total	21	21
PV Recovery of WC at end 5th year	1 * 0.7612=	-0.761
Cashoutflow		20.239
Free cashflow	30.64-20 = $10.64 Million
Pv of Free cashflow	25.598-20.239 = $ 5.359 Million
Calcualtion of WACC
Re	Rf+market risk premium*beta
	3+5.7*0.9
	8.13%
Stock Value	240
Net proceeds (p)	102
Facr Value (f)	100
Interest on bond	100*0.064 = 6.4
Kd	Interest (1-tax)+(f-p)/n
	(f+p)/2
	6.4(1-0.21)+(100-102)/13
	(100+102)/2
	4.85%
WACC
	Value(million)	Weights	Cost	WACC
Debt	800	0.77	4.85	3.73
Equity	240	0.23	8.13	1.88
	1040			5.61