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

$2

million and which it currently rents out for

$138,000.

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

$1.4

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

$489,000.

​ 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?

b. If the cost of capital is

15%​,

what is the NPV of the​ project?

Answer 1