A juice manufacturer conducted a marketing study three years ago to determine the consumers’ preferences for...

A juice manufacturer conducted a marketing study three years ago to determine the consumers’ preferences for different type of juices including organic juices. This study was very extensive and detrimental in their decision to start a new organic juice division today. It cost them $1,000,000 to perform this study.

The company is considering introducing organic juices. The company will add a new assembly line in order to produce the organic juices separate from their existing assembly line for regular non-organic juices.

The project has an anticipated life of 4 years.

The new assembly line has a cost of $1,500,000. It will require $500,000 to customize it to the new specifications for organic juice production, and $100,000 for transportation and shipping to the company’s plant.

The new machine falls into 5-years MACRS category (20%, 32%, 19.2%, 11.52%, 11.52% and 5.76%).

The organic juice production will require inventories to increase by $1,000,000 at time 0; in addition, accounts payables and accruals will increase by $450,000 and $150,000 respectively.

The organic juice is expected to generate sales revenue of $700,000 million the first year. The revenue is expected to increase by $300,000 every year. Each year the operating costs (excluding depreciation) are expected to equal 50 percent of sales revenue.

In order to do this expansion, the company will borrow $3 million. The annual interest expense on this borrowing $400,000.

The organic juice is expected to decrease the company’s existing non-organic juice sale by $350,000 per year before tax basis.

The company can sell the new machine at the end of 4 years for $50,000 in the market. The company’s cost of capital is 12 percent. The company’s tax rate is 40 percent.

What is the initial investment CF0?

What is the CF1 to be used in NPV calculations?

What is the non-operating cash flow for year 4?

What is cash flow 4 to be used in NPV calculations?

What is the NPV of the project?

Expert Solution


Answer 1				Working
Calculation of initial investment CF0				Depreciation calculation
	CF0			Year	Depreciable value of assembly line	Depreciation rate	Depreciation	Book value
Cost of new assembly line	-$1,500,000.00			1	2100000	20%	420000	1680000
Assembly line customization cost	-$500,000.00			2	2100000	32%	672000	1008000
Transportation and shipping cost	-$100,000.00			3	2100000	19.20%	403200	604800
Increase in Inventories	-$1,000,000.00			4	2100000	11.52%	241920	362880
Increase in accounts payable	$450,000.00			5	2100000	11.52%	241920	120960
Increase in accruals	$150,000.00			6	2100000	5.76%	120960	0
Initial Investment	-$2,500,000.00

Answer 2
Calculation of cash flow for Year 1 CF1
	CF1
Sales revenue (less decrease in non organic juice sale )	350000
Less : Operating cost	350000
less : Interest expense	400000
less : Depreciation	420000
Profit before tax	-820000
Less : Tax @ 40%	-328000
Profit after tax	-492000
Add : Depreciation	420000
Cash flow For Year 1	-72000

Answer 3
Non operating cash flow for Year 4
Sale value of plant	50000
Less : Book value of plant at the end of 4th year	362880
Loss on sale	-312880
Tax shield on Loss @ 40%	125152
Non operating cash flow for Year 4 (Sale value + Tax shield)	175152

Answer 4
Calculation of cash flow for Year 4 CF4
	CF4
Sales revenue	1250000
Less : Operating cost	800000
less : Interest expense	400000
less : Depreciation	241920
Profit before tax	-191920
Less : Tax @ 40%	-76768
Profit after tax	-115152
Add : Depreciation	241920
Add : Non operating cash flow	175152
Add : Recovery of net working capital	400000
Cash flow For Year 4	701920

Answer 5
Calculation of NPV
Year	Discount factor @ 12%	Cash flow	Present Value
0	1	-$2,500,000.00	-$2,500,000.00
1	0.892857143	-$72,000.00	-$64,285.71
2	0.797193878	$118,800.00	$94,706.63
3	0.711780248	$101,280.00	$72,089.10
4	0.635518078	$701,920.00	$446,082.85
NPV			-$1,951,407.13

Working
Calculation of cash flow for Year 2 & 3
	CF2	CF3
Sales revenue (less decrease in non organic juice sale )	650000	950000
Less : Operating cost	500000	650000
less : Interest expense	400000	400000
less : Depreciation	672000	403200
Profit before tax	-922000	-503200
Less : Tax @ 40%	-368800	-201280
Profit after tax	-553200	-301920
Add : Depreciation	672000	403200
Cash flow For Year 1	118800	101280

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