Question

IM DZ Chocolate Factory has just completed a 2 year $1.2 million market study related to the introduction of a new gourmet chocolate bar. Based on the results of the marketing survey, the company will be able to sell $382.4M in product. The increased variable costs are estimated at $320.0M and fixed costs are estimated to be an additional $28.4 million per year. The firm has a tax rate of 40% and projects require a 16 percent rate of return. The project will require an investment of $85.5 million to build the production facilities on land the company currently owns. The company will spend $16.3 million in net working capital and the land has a current market value of $4.5M. The million in production facilities belong in CCA class that has a CCA rate of 15%. The asset class will remain open at the end of the project. The project is expected to last 10 years and the assets will be sold for an estimated $20.4 million (excluding the land). The company will incur a one-time fully tax deductible expense of $3.3 million at time 0.

1. Calculate the initial investment for the project (I0).

2. Calculate the present value of the cash flows after tax from the operations.

3. Calculate the present value of the CCA tax shield.

4. Calculate the present value of the terminal cash flows.

5. Calculate the NPV of the project and explain your decision. 6. Is the IRR greater than, equal to or less than the required rate of return of 16 percent? Calculate the IRR. (A guess with no explanation is worth 0)

Answer 1

1	Initial investment of the project
	production facilities on the land	85.5	million $
	Net working capital	16.3	million $
	One time tax deductable expenses	3.3	million $
	Total investment	105.1
2	PV of cash flows after tax from operations
		Sales	Variable cost	Fixed cost	Net income	After tax *.6	PV @ 16 %
	Year 1	382.4	320	28	34	20.40	17.59
	Year 2	382.4	320	28	34	20.40	15.16
	Year 3	382.4	320	28	34	20.40	13.07
	Year 4	382.4	320	28	34	20.40	11.27
	Year 5	382.4	320	28	34	20.40	9.71
	Year 6	382.4	320	28	34	20.40	8.37
	Year 7	382.4	320	28	34	20.40	7.22
	Year 8	382.4	320	28	34	20.40	6.22
	Year 9	382.4	320	28	34	20.40	5.36
	Year 10	382.4	320	28	34	20.40	4.62
							98.60
3	PV of the CCA tax shields						16%
				Cost of asset	Dep @ 15 %	Tax Shield @ 40 %	PV @ 16 %
	Year 1			85.5	13	5.13	4.42
	Year 2			73	11	4.36	3.24
	Year 3			62	9	3.71	2.37
	Year 4			53	8	3.15	1.74
	Year 5			45	7	2.68	1.27
	Year 6			38	6	2.28	0.93
	Year 7			32	5	1.93	0.68
	Year 8			27	4	1.64	0.50
	Year 9			23	3	1.40	0.37
	Year 10			20	3	1.19	0.27
				PV of all tax shields			15.81
4	PV of the assets sold at 10 year @ 16 %				20.4	20.4	4.62
	(Terminal cash flows )
5	NPV of the project = - initial investment + pv of all cash flows + terminal cash flows
	: = -105.1 + 98.6 + 4.62 + 15.81 + (3.3*.40)
	15.25	million $	IRR is greater than 16 %