Question

) Suppose you work for Meijer, a large grocer headquartered in Michigan. 20 years ago, Meijer bought a parcel of land on the outskirts of Lafayette, Indiana. It is currently being rented to a farmer. They intended to build a new store on the lot after a proposed new highway was complete. However, when the new highway was built it went in a different direction and now they must decide whether to build the new store. You ask around and find the following information from the following departments (all numbers are in thousands of dollars):
The sales department tells you: Annual Revenue: $2400
The operations department tells you: Inventory Required on Shelves: $140 Annual Cost of Goods Sold: $1500 Annual Cost of Running Store: $500 Annual Allocated Overhead from HQ: $80
The forecasting department tells you: Loan to fund construction: $300 Interest Rate: 4%, loan is interest only (no principle payments) Weighted Average Cost of Capital: 13% Depreciation Schedule: Straight-line depreciation over 40 years Tax Rate: 30%
The construction department tells you: Cost of environmental review (already completed): $65 Purchase Price of Land 20 years ago: $1000 (hint: land is not depreciated) Current Market Value of Land: $1100 (hint: land is not depreciated) Current Pre-Tax Income from renting land out: $75/year Cost of Construction (Labor & Materials): $1800

1a) Your boss tells you to find the unleveraged incremental cash flow of the project for the next four years. Write your answer in the form of a pro forma statement on the next page.
1b) Should you approve this project? Why or why not?

Answer 1

Q.1a)

Net Profit for each year

Particulars	Amount ('000$)
Annual revenue	2400
Less: Annual cost of goods sold	1500
Less: Cost of running stores	500
Less:Allocated OH from HQ	80
Less: Interest on fund ( 300*4%)	12
Less: Depreciation (1800/40)	45
Net Profit	263
Tax @30% on Net profit	78.90

Calculation of annual Incremental cash flow:

Particulars	Amount ('000$)
Annual revenue	2400
Less: Annual cost of goods sold	1500
Less: Cost of running stores	500
Less: Interest on fund ( 300*4%)	12
Less: Opportunity cost of Lease rent (Rent foregone)	75
Less: Tax paid on Net profit	78.90
Annual Incremental cash flow	234.1

Cash flow for year-1: Annual Incremental cashflow + cash inflow of debt fund - Cost of construction

= 234.1 + 300 -1800 = - 1265.90

Cash flow from year 2 to 4 = Annual incremental cash flow = 234.1

Q1b)

The cash flow for the next 40 years = 234.1*40 - 1800 = 7564

Since the net cash flow is positive the project can be approved