Question

Healthy Foods Company (HFC) currently processes seafood with a unit it purchased
several years ago. The unit, which originally cost $500,000, has a current book value of
$250,000. HFC is
considering replacing the existing unit with a newer, more efficient one.Thenewunitwillcost$
750,000 and will also require an initial increase in net working capital of $40,000. The
new unit will be depreciated on a straight‐line basis over five years to a zero balance.
The existing unit is being depreciated at a rate of $50,000 per year. HFC expects to sell
the existing machine today for $275,000. HFC’s tax rate is30%.
If HFC purchases the new unit, annual revenues are expected to increase by $100,000
(due to increased capacity), and annual operating costs (exclusive of depreciation) are
expected to decrease by $20,000. Annual revenues and operating costs are expected to
remain constant at this new level over the five‐year life of the project. Accumulated net
working capital will be recovered at the end of five years.
HFC’s (Simplified) Balance sheet is below:

Assets Liabilities &Equity

Current Assets 200,000 Debt 480,000
Fixed Assets 1,000,000 Equity 720,000

HFC’s equity beta is 1.3, the cost of debt is 10% and the risk‐free rate and market return are
8% and 14% respectively.

Answer the following

(a) Calculate the project’s initial net investment.
.

(b) Calculate the annual net operating cash flows for the project.

Answer 1