Question

Quantitative Problem: 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 $4.1 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 $4,100,000/5 = $820,000. 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 $1,500,000 before taxes.

The project will require an increase in net operating working capital of $730,000 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	$2,100,000
2	8,000,000
3	3,150,000

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.

NPV	$
IRR	%

SSC is considering another project: the introduction of a "weight loss" smoothie. The project would require a $3.2 million investment outlay today (t = 0). The after-tax cash flows would depend on whether the weight loss smoothie is well received by consumers. There is a 40% chance that demand will be good, in which case the project will produce after-tax cash flows of $2.3 million at the end of each of the next 3 years. There is a 60% chance that demand will be poor, in which case the after-tax cash flows will be $0.49 million for 3 years. The project is riskier than the firm's other projects, so it has a WACC of 11%. The firm will know if the project is successful after receiving the cash flows the first year, and after receiving the first year's cash flows it will have the option to abandon the project. If the firm decides to abandon the project the company will not receive any cash flows after t = 1, but it will be able to sell the assets related to the project for $2.25 million after taxes at t = 1.

Assuming the company has an option to abandon the project, what is the expected NPV of the project today? Round your answer to 2 decimal places. Do not round your intermediate calculations. Use the values in "millions of dollars" to ascertain the answer.

$  millions of dollars

Answer 1

	Year 0	1	2	3
Investment in additional Equipment	-4100000
Investment& recovery of NWC	-730000			730000
After-tax cash flow on salvage				1556000
CAPEX & NWC Cash flows-----1	-4830000			2286000
Operating cash flow
Sales		2100000	8000000	3150000
Less:Cost of sales		1260000	4800000	1890000
Less: Depreciation		820000	820000	820000
EBIT		20000	2380000	440000
Tax at 40%		8000	952000	176000
EAT		12000	1428000	264000
Add Back Depn		820000	820000	820000
Opg. Cash flow------2		832000	2248000	1084000
Net annual cash flow(1+2)	-4830000	832000	2248000	3370000
PV F at 10%	1	0.90909	0.82645	0.75131
PV at 10%	-4830000	756364	1857851	2531931
NPV	316146
IRR of net annual cash flows	13%
St.line Annual depn( 4100000/5)	820000
Acc.depn.at end of 3 years(820000*3)	2460000
Carrying value(4100000-2460000)	1640000
Sale value at end Yr.3	1500000
Loss on sale(1640000-1500000)	140000
Tax savings on loss(40%*140000)	56000
So,after-tax cash flow on sale of equipment(1500000+56000)	1556000