Question

FTG commissioned a study to look into the feasibility of changing the packaging of the fruit from cans to sealed bags. The Consultant charged $54,000 for the report.

The report concluded that the new packaging will increase sales and reduce some operating costs.

The new packaging machinery will cost $1,100,000. The new machine is expected to last 5 years. The Taxation Office advise the life of the machine, for tax purposes, is 4 years.

The old canning machinery was purchased 2 years ago for $800,000 and was being depreciated at $200,000 and will be for the next 2 years. The old machine could be sold today for $260,000. In 5 years it will be worth nothing.

Installing the new machine will require staff training (a tax deductible expense) of $35,000 before production can commence. Due to the lower cost of the bags Inventory required will be reduced by $80,000 for the life of the project.

The new sales of bagged fruit is expected to be $700,000 in Year 1 rising by 15% for 2 years then 0% for the rest of the life of the project. Variable Costs associated with the new packaged fruit are 50% of sales.

Canned fruit production will be discontinued. Sales of canned fruit were static at $450,000 with variable costs of $225,000 (50% of Sales).

The new equipment is very hi-tech. Maintenance costs are expected to be higher at $44,000 per year. Maintenance costs on the old machine were $30,000 per year.

The lighter packaging will reduce annual freight cost significantly from $250,000 to $100,000 per year.

Fixed costs are expected to remain at $320,000 per year.

At the end of the project the new machinery can be sold for $275,000.

Notes:

FTG will borrow the full Year 0 funds using a secured five-year interest-only loan at an interest rate of 10% per annum to finance the new equipment.

The company tax rate is 30%.

The required rate of return is 12.5%.

Requirement:

5. The NPV of the project （5Marks）

6. The IRR of the project（5Marks）

7. The PI of the project（5Marks）

Answer 1

Year	0	1	2	3	4	5
1.Initial cost	-1100000
2.ATCF on sale of old m/c	302000
3.After-tax staff training expenses (35000*(1-30%))	-24500
4.NWC reduced & restored	80000					-80000
5.ATCF on sale of new m/c(275000*(1-30%))						192500
Operating cash flows:
6.Sale of bagged fruits		700000	805000	925750	925750	925750
7.Variable costs(Sales*50%)		-350000	-402500	-462875	-462875	-462875
8.Lost contribution form canned fruit sales		-225000	-225000	-225000	-225000	-225000
9.Incl. maintenance costs(44000-30000)		-14000	-14000	-14000	-14000	-14000
10.Savings in freight costs(250000-100000)		150000	150000	150000	150000	150000
11.Depn. Of new m/c(1100000/4)		-275000	-275000	-275000	-275000
12.Incl. EBIT(sum 6 to 11)		-14000	38500	98875	98875	373875
13.Tax at 30%(12*30%)		4200	-11550	-29662.5	-29662.5	-112162.5
14.NOPAT(12+13)		-9800	26950	69212.5	69212.5	261712.5
15.Add Back: depn.		275000	275000	275000	275000	0
16. Depn. Tax shield on old m/c lost(200000*30%)		-60000	-60000
17.Operating cash flow(15+16+17)		205200	241950	344212.5	344212.5	261712.5
18.Total Annual FCFs(1+2+3+4+5+17)	-742500	205200	241950	344212.5	344212.5	374212.5
19.PV F at 12.5%(1/1.125^Yr.n)	1	0.88889	0.79012	0.70233	0.62430	0.55493
20.PV at 12.5%(18*19)	-742500	182400.00	191170.37	241751.44	214890.17	207661.35
21.NPV(sum of row 20)	295373.33
22.IRR (of FCF row 18 )	25.95%
23.PI=1+NPV/Initial Investment)
24. ie.1+ (295373.33/742500)=
1.40

Workings--ATCF on sale of old m/c
Book value of old m/c at yr.0(800000-(200000*2))=	400000
Sale value at t=0	260000
Loss on sale	140000
Tax saved on loss	42000
ATCF on sale of old m/c	302000