Question

Arnold Inc. is considering a proposal to manufacture​ high-end protein bars used as food supplements by body builders. The project requires use of an existing​warehouse, which the firm acquired three years ago for $4 million and which it currently rents out for $123,000. Rental rates are not expected to change going forward. In addition to using the​ warehouse, the project requires an upfront investment into machines and other equipment of $1.5 million. This investment can be fully depreciated​ straight-line over the next 10 years for tax purposes. ​ However, Arnold Inc. expects to terminate the project at the end of eight years and to sell the machines and equipment for $422,000. Finally, the project requires an initial investment into net working capital equal to 10 percent of predicted​ first-year sales.​Subsequently, net working capital is 10 percent of the predicted sales over the following year. Sales of protein bars are expected to be $4.7 million in the first year and to stay constant for eight years. Total manufacturing costs and operating expenses​ (excluding depreciation) are 80 percent of​ sales, and profits are taxed at 30 percent. a. What are the free cash flows of the​ project?

The FCF for year 0 is $............... million. ​ (Round to three decimal​ places.)

The FCF for years​ 1-7 is $............ million. ​ (Round to three decimal​ places.)

The FCF for year 8 is $........ million. ​ (Round to three decimal​ places.) b. If the cost of capital is 15%​, what is the NPV of the​ project?

The NPV of the project is $............ million. ​ (Round to three decimal​ places.)

Answer 1

Depreciation = 1.5 /10 = 0.15 million

after tax sale value:

book value after 8 years = purchase value - depreciation

= 1.5 - (0.15*8)

= 0.3

sale value = 0.422

profit = 0.422 - 0.30 = 0.122

tax = 0.122*30% = 0.0366

after tax value = 0.422 - 0.0366 = 0.3854

FCF for Year 0 is $ -1.970 million (since it is an outflow negative sign may be included)

FCF for 1 - 7 is $ 0.617 million

FCF for year 8 is $ 1.472 million

NPV of the project is $ 1.078 million