Question

Delicious Snacks, Inc. is considering adding a new line of candies to its current product line. The company already paid $300,000 for a marketing research study that provided evidence about the demand for this product at this time. The new line will require an additional investment of $70,000 in raw materials to produce the candies. The project’s life is 7 years and the firm estimates sales of 1,500,000 packages at a price of $1 per unit the first year; but this volume is expected to grow at 17% for the next two years, 12% for the following two years, and finally at 7% for the last two years of the project. The price per unit is expected to grow at the historical average rate of inflation of 3%. The variable costs will be 70% of sales and the fixed costs will be $500,000. The equipment required to produce the candies will cost $900,000, and will require an additional $30,000 to have it delivered and installed. This equipment has an expected useful life of 7 years and will be depreciated using the MACRS 5-year class life. After 7 years, the equipment can be sold at a price of $200,000. The cost of capital is 9% and the firm’s marginal tax rate is 35%.

Please show any detailsl in the EXCEL!!!!! Thank you

a) Calculate the initial investment, annual after-tax cash flows for each year, and the terminal cash flow.

b) Determine the NPV, IRR, and MIRR of the new line of candies. Should the firm accept or reject the project?

Answer 1

total cost of equipment = purchase cost + installation cost

The amount spent on marketing study is a sunk cost and should not be considered in the cash flow analysis.

Operating cash flow (OCF) each year = income after tax + depreciation

In year 7, the entire investment in raw materials is recovered.

profit on sale of equipment at end of year 7 = sale price - book value

book value is zero as the equipment is fully depreciated.

after-tax salvage value = salvage value - tax on profit on sale of equipment   

NPV, IRR and MIRR are calculated using NPV, IRR and MIRR functions in Excel

NPV is $86,174

IRR is 10.84%

MIRR is 10.29%