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 $ 3million and which it currently rents out for $108,000. 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 $1.4million. 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 $472,000. ​ 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 $ 4.9million 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 ​$ ____million. ​ (Round to three decimal​ places.)
The FCF for years​ 1-7 is ​$____million. ​ (Round to three decimal​ places.)
The FCF for year 8 is ​$_____ 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 ​$_____million. ​ (Round to three decimal​ places.)

Answer 1

The cost of existing warehouse is a sunk cost because it was acquired in the past, hence it is irrelevant and not to be considered in calculating incremental cash flows

Operating cash flow (OCF) each year = income after taxes + depreciation

Profit on salvage value = salvage value - (machinery cost - accumulated depreciation)

NPV is calculated using NPV function in Excel