Question

Arnold Inc. is considering a proposal to manufacture high-end protein bars used as food supplements by bodybuilders. The project requires the use of an existing warehouse, which the firm acquired three years ago for $3 million and which it currently rents out for $101,000.

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 $1.3 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 $492,000. 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$4.6 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?

The FCF for years 1-7 is?

The FCF for year 8 is?

b. If the cost of capital is?

The NPV of the project is?

Answer 1

		0	1	2	3	4	5	6	7	8
a)	Sales		4600000	4600000	4600000	4600000	4600000	4600000	4600000	4600000
	Manufacturing and operating costs (80% of sales)		3680000	3680000	3680000	3680000	3680000	3680000	3680000	3680000
			[4600000*80%]
	Depreciation [1300000/10]		130000	130000	130000	130000	130000	130000	130000	130000
			[1300000/10]
	Loss of rent on warehouse		101000	101000	101000	101000	101000	101000	101000	101000
	NOI		689000	689000	689000	689000	689000	689000	689000	689000
			[3680000-130000-101000-689000]
	Tax at 30%		206700	206700	206700	206700	206700	206700	206700	206700
			[689000*30%]
	NOPAT		482300	482300	482300	482300	482300	482300	482300	482300
	Add: Depreciation		130000	130000	130000	130000	130000	130000	130000	130000
	OCF		612300	612300	612300	612300	612300	612300	612300	612300
	Capital expenditure	1300000
	Increase in NWC (10% of 4600000)	460000								-460000
	After tax salvage value [492000-(492000-260000)*30%]									422400
	FCF	-1760000	612300	612300	612300	612300	612300	612300	612300	1494700
b)	Cost of capital 10% (assumed as no figure is ginven in
	the question)
	PVIF at 10% [PVIF = 1/1.1^n]	1	0.90909	0.82645	0.75131	0.68301	0.62092	0.56447	0.51316	0.46651
			[1/1.1]	[1/1.1^2]	[1/1.1^3]	[1/1.16^4]	]1/1.1^5]	[1/1.1^6]	[1/1.1^7]	[1/1.1^8]
	PV at 10%	-1760000	556636	506033	460030	418209	380190	345627	314207	697289
	NPV	$ 19,18,221