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 $ 1 million and which it currently rents out for $ 109 comma 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 $ 526 comma 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

Based on the given data, pls find below steps, workings and answers:

Yearwise Free Cash flows as highlighted in yellow;

Assumed that the working capital is consumed over the period and since no mention in the given data about the recovery at the terminal year, have not considered the same;

NPV of the Project positive $ 1161144.03 and this project is recommended;

Computation of Net Present Value (NPV) based on the Discounted Cash flows; The Discounting factor is computed based on the formula: For year 0, the discounting factor is 1; For Year 1, it is computed as = Year 0 factor /(1+discounting factor%) ; Year 2 = Year 1 factor/(1+discounting factor %) and so on;

Next, the cashflows need to be multiplied with the respective years' discounting factor, to arrive at the discounting cash flows;

The total of all the discounted cash flows is equal to its respective Project NPV of the Cash Flows;