Question

Apollo is considering a new expansion project, Project S. Project S is a new health-food product that Allied is thinking of introducing to the market. Along the way, Allied’s finance staff has received a lot of information, the highlights of which are summarized below:

 Project S will require Apollo to purchase $900,000 of equipment in 2013 (t = 0).

 Inventory will increase by $175,000 and accounts payable will rise by $75,000. All other working capital

components will stay the same, so the change in net operating working capital (NOWC) is $100,000 at t = 0.

 The project will last for 4 years. The company forecasts that they will sell 2,685,000 units in 2014, 2,600,000

units in 2015, 2,525,000 units in 2016, and 2,450,000 units in 2017. Each unit will sell for $2.

 The fixed cost of producing the product is $2 million each year, and the variable cost of producing each unit

will rise from $1.018 in 2014 to $1.221 in 2017. (assume it is $1.078 in 2015 and $1.046 in 2016).

 The company will use accelerated depreciation and write off 33% of the basis during Year 1, 45% in year 2,

15% in Year 3 and 7% in Year 4.

 When the project is completed in 2017 (t = 4), the company expects it will be able to salvage the equipment for

$50,000, and it expects that it will fully recover the NOWC of $100,000.

 The estimated tax rate is 40%.

 Based on the perceived risk, the project’s WACC is estimated to be 10%.

Evaluate the project’s NPV, IRR, MIRR and payback.

Answer 1

	Equipment purchase cost	$         900,000
	Depreciation details	2013	2014	2015	2016	2017
	Depreciation Rates		33%	45%	15%	7%
	Annual Depreciation expense		$           297,000	$       405,000	$           135,000	$            63,000

	Salvage value in 2017	$           50,000
	Book value at 2017 end	$                    -
	Capital gains on salvage	$           50,000
	Tax on Capital Gain @40%	$           20,000
	After Tax salvage value	$           30,000

	Operaions details
x	Units sold		2,685,000	2,600,000	2,525,000	2,450,000
y	Variable cost per unit		$               1.018	$           1.078	$               1.046	$              1.221

	Capital Investment Evaluation	2013	2014	2015	2016	2017
	Initial Investment
	Equipment cost	$       (900,000)
	Incremental NWC
	Increase in Inventory	$       (175,000)
	Increase in AP	$           75,000
	Net Increase in WC	$       (100,000)
a	Total initial Investment	$    (1,000,000)
	Cash flow from Operations
	Incremental sales revenue @$2/unit(x*2)		$        5,370,000	$    5,200,000	$       5,050,000	$       4,900,000
	Incremental variable cost=(x*y)		$        2,733,330	$    2,802,800	$       2,641,150	$       2,991,450
	Fixed cost		$        2,000,000	$    2,000,000	$       2,000,000	$       2,000,000
	Depreciation expense		$           297,000	$       405,000	$           135,000	$            63,000
	Taxable Income		$           339,670	$          (7,800)	$           273,850	$        (154,450)
	Tax @40%		$        135,868.0	$      (3,120.0)	$       109,540.0	$       (61,780.0)
	After Tax Income		$        203,802.0	$      (4,680.0)	$       164,310.0	$       (92,670.0)
	Add Back depreciation		$           297,000	$       405,000	$           135,000	$            63,000
b	Total Cash flow from Operations		$        500,802.0	$    400,320.0	$       299,310.0	$       (29,670.0)
	Terminal Cash flow
	After Tax Salvage					$            30,000
	Return of NWC					$          100,000
c	Total Terminal Cash flow					$          130,000
d	Total Cash flow from Project =a+b+c	$    (1,000,000)	$           500,802	$       400,320	$           299,310	$          100,330
e	PV discount factor @10% =1/1.1^n=	1.0000	0.9091	0.8264	0.7513	0.6830
f	PV of Cash flows =d*e=	$    (1,000,000)	$           455,279	$       330,824	$           224,872	$            68,525
g	NPV =Sum of PV of Cash flows =	$           79,501
h	IRR (using excel function )=	14.53%

i	MIRR
	FV of Cash inflows =500802*1.12^3+400320*1.12^2+299310*1.12+100330			$    1,641,309
	PV of Cash out flows =	$      1,000,000
	Time period =4
	MIRR =(1641309/1000000)^(1/4)-1 =	13.19%
	Payback period in years =	2.33