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. This equipment is eligible for 100% bonus depreciation, so the equipment is fully depreciated at the time of its purchase. 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 $650,000 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	$3,200,000
  2	7,900,000
  3	2,950,000

• The project's annual operating costs (excluding depreciation) are expected to be 60% of sales.
• The company's tax rate is 25%.
• 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		25%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3			Total
Cost		$    4,900,000	$   4,900,000	$    4,900,000
Dep Rate		100.00%	0.00%	0.00%
Depreciation	Cost * Dep rate	$    4,900,000	$                -	$                 -			$    4,900,000
Calculation of after-tax salvage value
Cost of machine			$   4,900,000
Depreciation			$   4,900,000
WDV	Cost less accumulated depreciation	$                -
Sale price			$   2,300,000
Profit/(Loss)	Sale price less WDV	$   2,300,000
Tax	Profit/(Loss)*tax rate	$      575,000
Sale price after-tax	Sale price less tax		$   1,725,000
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3
Sale		$    3,200,000	$   7,900,000	$    2,950,000
Less: Operating Cost-60%		$    1,920,000	$   4,740,000	$    1,770,000
Contribution		$    1,280,000	$   3,160,000	$    1,180,000
Less: Depreciation		$    4,900,000	$                -	$                 -
Profit before tax (PBT)		$ (3,620,000)	$   3,160,000	$    1,180,000
Tax@25%	PBT*Tax rate	$     (905,000)	$      790,000	$       295,000
Profit After Tax (PAT)	PBT - Tax	$ (2,715,000)	$   2,370,000	$       885,000
Add Depreciation	PAT + Dep	$    4,900,000	$                -	$                 -
Cash Profit after-tax		$    2,185,000	$   2,370,000	$       885,000
Calculation of NPV
						10.00%
Year		Capital	Working capital	Operating cash	Annual Cash flow	PV factor, 1/(1+r)^time	Present values
0		$ (4,900,000)	$     (650,000)		$ (5,550,000)	1.0000	$ (5,550,000)
1				$    2,185,000	$    2,185,000	0.9091	$    1,986,364
2				$    2,370,000	$    2,370,000	0.8264	$    1,958,678
3		$    1,725,000	$      650,000	$       885,000	$    3,260,000	0.7513	$    2,449,286
					Net Present Value	$       844,328
Calculation of IRR
			17.00%		18.00%
Year		Total cash flow	PV factor @ 17%	Present values	PV factor @ 18%	Present values
0		$ (5,550,000)	1.000	$ (5,550,000)	1.000	$ (5,550,000)
1		$    2,185,000	0.855	$    1,867,521	0.847	$   1,851,695
2		$    2,370,000	0.731	$    1,731,317	0.718	$   1,702,097
3		$    3,260,000	0.624	$    2,035,448	0.609	$   1,984,137
				$         84,286		$       (12,071)
		IRR	=Lower rate + Difference in rates*(NPV at lower rate)/(Lower rate NPV-Higher rate NPV)
		IRR	'=17%+ (18%-17%)*(84286.4/(84286.4-(-12071.)
			17.87%