Question

Arnold Inc. is considering a proposal to manufacture​ high-end protein bars used as food supplements by body builders. The project requires use of an existing​ warehouse, which the firm acquired three years ago for

$2

million and which it currently rents out for

$101,000.

Rental rates are not expected to change going forward. In addition to using the​ warehouse, the project requires an upfront investment into machines and other equipment of

$1.5

million. This investment can be fully depreciated​ straight-line over the next 10 years for tax purposes. ​ However, Arnold Inc. expects to terminate the project at the end of eight years and to sell the machines and equipment for

$438,000.

​ Finally, the project requires an initial investment into net working capital equal to 10 percent of predicted​ first-year sales.​ Subsequently, net working capital is 10 percent of the predicted sales over the following year. Sales of protein bars are expected to be

$4.7

million in the first year and to stay constant for eight years. Total manufacturing costs and operating expenses​ (excluding depreciation) are 80 percent of​ sales, and profits are taxed at 30 percent.

a. What are the free cash flows of the​ project?

b. If the cost of capital is

15%​,

what is the NPV of the​ project?

a. What are the free cash flows of the​ project?

The FCF for year 0 is

​$nothing

million. ​ (Round to three decimal​ places.)The FCF for years​ 1-7 is

​$nothing

million. ​ (Round to three decimal​ places.)The FCF for year 8 is

​$nothing

million. ​ (Round to three decimal​ places.)b. If the cost of capital is

15%​,

what is the NPV of the​ project?The NPV of the project is

​$nothing

million. ​ (Round to three decimal​ places.)

Answer 1

Note 2: For understanding it is important to note that, we have calculated the depreciation for the assets based on the useful life of 10 years (and not 8 years) and have taken no salvage value because it is metioned in the question that the asset shall be depreciated fully for tax purposes. However, while calculating after tax salvage value depreciation has been taken only for 8 years - because that's when the asset is being disposed off.

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