Question

Jennifer is a project manager for Cyclone Fitness Inc. She is evaluating the feasibility of a project to build a new plant for manufacturing a new health drink. She has the following information. · Sales of 800,000 bottles/year with a price of $5/bottle. · Variable cost per bottle is $1.5 per bottle. · Fixed costs are $500,000 per year. · Project life is 5 years. · Initial Investment (cash outlay) is $5,000,000. · Depreciation is $1,000,000/year. · Additional net working capital of $1,500,000 required. Same for all periods. · The firm’s required return is 22%. · The tax rate is 30%.

a. What is the OCF in year 1 to year 5?

b. What is the (Free) Cash Flow in year 1 to year 5?

c. What is the NPV of the project? Should Cyclone Fitness Inc. accept or reject the project?

Answer 1

Free Cash Flow = Operating Cash Flow - Change in working capital - Change in Fixed Assets

Therefore operating cash flow and free cash flow will be same in this question because there is no information given on increase in working capital from year 1-5, nor there is any information on change in fixed assets

Particulars	Cash Flow
Sales 800000 * 5	4,000,000
Variable cost 800000 * 1.5	1,200,000
Less Fixed cost	500,000
Operating Profit	2,300,000
Less : Depreciation	1,000,000
Earning Before Tax	1,300,000
Less : Tax	390,000
Earning After Tax	910,000
Add Back : Depreciation	1,000,000
Cash flow After Tax / Operating Cash Flow	1,910,000

PV of this Cash Flow
CFAT	1,910,000
PVAF 22%, 5 Years	2.86
PV of CFAT (B)	5,469,551.94

A. Initial Investment (Year 0)
Cost of Machine	5,000,000
Increase in Working Capital	1,500,000
Total Outlow (A)	6,500,000

Recovery of Working Capital	1,500,000
Total Terminal Cash Flow	1,500,000
Present Value Factor	0.37
Present Value of Terminal Cash Flow {C}	554,998.88

Calculation Of NPV
Initial Outflow (A)	-6,500,000
PV of Annual Cash Flow (B)	5,469,551.94
PV of Terminal Cash Flow "C"	554,998.88
Net Present Value	-475,449

NPV is negative we should reject the project