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Use the following information to answer questions 1-3. Mitts Beverage Inc. manufactures and distributes fruit juice...

Use the following information to answer questions 1-3.

Mitts Beverage Inc. manufactures and distributes fruit juice products. Mitts is considering the development of a new prune juice product. Mitts’ CFO has collected the following information regarding the proposed project:

· The company already owns a section of land where the facility could be built. The land is estimated to have a after tax market value of $1 million. The company plans to sell the land if it is not used for this project.

· The project will require that the company spend $1 million today (t = 0) to purchase a new machine. For tax purposes, the equipment will be depreciated on a straight-line basis. The company plans to use the machine for all 3 years of the project. At t = 3, the equipment is expected to have no salvage value.

· The project will require a $400,000 increase in inventory and $200,000 increase in accounts payable at t = 0. The cost of the net operating working capital will be fully recovered at t = 3.

· The project's incremental sales are expected to be $1 million a year for three years (t = 1, 2, and 3).

· The project’s annual operating costs (excluding depreciation) are expected to be 60% of sales.

· The company’s tax rate is 40%.

· The company’s interest expense each year will be $300,000.

· The project’s discount rate is 10%.

1. What is the initial investment for the project?

2. What is the annual expected incremental operating cash flow for years 1-3?

3. What is the project’s NPV?

Solutions

Expert Solution

Initial Investment
cost of new machine -1000000
Investment in working capital -200000 -200000
total initial investment -1200000
Annual expected incremental operating cash flow 1 2 3
Incremental sales 1000000 1000000 1000000
less operating cost -60% of sales 600000 600000 600000
less annual depreciation =(1000000/3) 333333.3333 333333.3333 333333.3333
operating profit 66666.66667 66666.66667 66666.66667
less taxes-40% 26666.66667 26666.66667 26666.66667
after tax profit 40000 40000 40000
add depreciation 333333.3333 333333.3333 333333.3333
recovery of working capital 200000
Annual expected incremental operating cash flow 373333.3333 373333.3333 573333.3333
NPV
Year 0 1 2 3
total initial investment -1200000
Annual expected incremental operating cash flow 373333.3333 373333.3333 573333.3333
present value factor at 10% =1/(1+r)^n r =10% 1 0.909090909 0.826446281 0.751314801
present value of expected incremental operating cash flow = incremental operating cash flow*PVF at 10% -1200000 339393.9394 308539.9449 430753.8192
NPV = sum of present value of incremental operating cash flow -121312.30

jeff jeffy answered 1 hour ago
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