Question

Sunshine Smoothies Company (SSC) manufactures and distributes smoothies. SSC is considering the development of a new line of high-protein energy smoothies. SSC's CFO has collected the following information regarding the proposed project, which is expected to last 3 years: The project can be operated at the company's Charleston plant, which is currently vacant. The project will require that the company spend $4.9 million today (t = 0) to purchase additional equipment. For tax purposes the equipment will be depreciated on a straight-line basis over 5 years. Thus, the firm's annual depreciation expense is $4,900,000/5 = $980,000. The company plans to use the equipment for all 3 years of the project. At t = 3 (which is the project's last year of operation), the equipment is expected to be sold for $2,300,000 before taxes. The project will require an increase in net operating working capital of $700,000 at t = 0. The cost of the working capital will be fully recovered at t = 3 (which is the project's last year of operation). Expected high-protein energy smoothie sales are as follows: Year Sales 1 $2,400,000 2 7,850,000 3 3,500,000 The project's annual operating costs (excluding depreciation) are expected to be 60% of sales. The company's tax rate is 40%. The company is extremely profitable; so if any losses are incurred from the high-protein energy smoothie project they can be used to partially offset taxes paid on the company's other projects. (That is, assume that if there are any tax credits related to this project they can be used in the year they occur.) The project has a WACC = 10.0%. What is the project's expected NPV and IRR? Round your answers to 2 decimal places. Do not round your intermediate calculations.

Answer 1

Tax rate	40%
	Year-1	Year-2	Year-3
Sale	2,400,000	7,850,000	3,500,000
Less: Operating Cost @ 60%	1,440,000	4,710,000	2,100,000
Contribution	960,000	3,140,000	1,400,000
Less: Depreciation as per table given below	980,000	980,000	980,000
Profit before tax	(20,000)	2,160,000	420,000
Tax	(8,000)	864,000	168,000
Profit After Tax	(12,000)	1,296,000	252,000
Add Depreciation	980,000	980,000	980,000
Cash Profit After tax	968,000	2,276,000	1,232,000
Cost of macine		4,900,000
Depreciation		2,940,000
WDV		1,960,000
Sale price		2,300,000
Profit/(Loss)		340,000
Tax		136,000
Sale price after tax		2,164,000
Depreciation	Year-1	Year-2	Year-3			Total
Cost	4,900,000	4,900,000	4,900,000
Dep Rate	20.00%	20.00%	20.00%
Deprecaition	980,000	980,000	980,000			2,940,000
Calculation of NPV
					10.00%
Year	Captial	Working captial	Operating cash	Annual Cash flow	PV factor	Present values
0	(4,951,000)	(700,000)		(5,651,000)	1.000	(5,651,000)
1			968,000	968,000	0.909	880,000
2			2,276,000	2,276,000	0.826	1,880,992
3	2,164,000	700,000	1,232,000	4,096,000	0.751	3,077,385
				Net Present Value		187,377
Calculation of IRR
Year	Total cash flow	PV factor @ 10%	Present values	PV factor @ 12%	Present values
0	(5,651,000)	1.000	(5,651,000)	1.000	(5,651,000)
1	968,000	0.909	880,000	0.893	864,286
2	2,276,000	0.826	1,880,992	0.797	1,814,413
3	4,096,000	0.751	3,077,385	0.712	2,915,452
			187,377		(56,849)
	IRR	=Lower rate + Difference in rates*(NPV at lower rate)/(Lower rate NPV-Higher rate NPV)
	IRR	=10%+2%*(187377/(187377+56849))
		11.53%