Question

TexMex Food Company is considering a new salsa whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no change in net operating working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life. However, this project would compete with other TexMex products and would reduce their pre-tax annual cash flows. What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.) Do not round the intermediate calculations and round the final answer to the nearest whole number.

WACC	10.0%
Pre-tax cash flow reduction for other products (cannibalization)	-$5,000
Investment cost (depreciable basis)	$80,000
Straight-line depr. rate	33.333%
Annual sales revenues	$66,500
Annual operating costs (excl. depr.)	-$25,000
Tax rate	35.0%

Answer 1

Time line		0	1	2	3
Cost of new machine		-80000
=Initial Investment outlay		-80000
						100.00%
Sales			61500	61500	61500
Profits	Sales-variable cost		36500	36500	36500
-Depreciation	Cost of equipment/no. of years		-26666.6667	-26666.6667	-26666.6667	0	=Salvage Value
=Pretax cash flows			9833.333333	9833.333333	9833.333333
-taxes	=(Pretax cash flows)*(1-tax)		6391.666667	6391.666667	6391.666667
+Depreciation			26666.66667	26666.66667	26666.66667
=after tax operating cash flow			33058.33	33058.33	33058.33
+Tax shield on salvage book value	=Salvage value * tax rate				0
=Terminal year after tax cash flows					0
Total Cash flow for the period		-80000	33058.33	33058.33	33058.33
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331
Discounted CF=	Cashflow/discount factor	-80000	30053.02727	27320.93388	24837.21262
NPV=	Sum of discounted CF=	2211