Question

1. Delicious Snacks, Inc. is considering adding a new line of candies to its current product line. The company already paid $300,000 for a marketing research study that provided evidence about the demand for this product at this time. The new line will require an additional investment of $50,000 in raw materials to produce the candies. The project’s life is 7 years and the firm estimates sales of 500,000 packages at a price of $5 per unit the first year; but this volume is expected to grow at 12% for the next three years, 10% for the last three years of the project. The price per unit is expected to grow at 5% for the next two years, and then at the historical average rate of inflation of 3% for the last four years of the project. The variable costs will be 65% of sales and the fixed costs will be $450,000.

The equipment required to produce the candies will cost $1,400,000, and will require an additional $50,000 to have it delivered and installed. This equipment has an expected useful life of 7 years and will be depreciated using the MACRS 5-year class life. After 7 years, the equipment can be sold at a price of $200,000. The cost of capital is 12% and the firm’s marginal tax rate is 35%.

1. Calculate the initial investment, annual after-tax cash flows for each year, and the terminal cash flow.
2. Determine the payback period, discounted payback period, NPV, PI, IRR, and MIRR of the new line of candies. Should the firm accept or reject the project?
3. The firm is considering three scenarios for the new line of cookies and bars. Under the best, base, and worst case scenario the firm will sell 450,000, 500,000, and 600,000 packages the first year with the same expected growth rates in units and price described in the problem. Re-examine the decision criteria in part (a) under each of these scenarios.

	1	2	3	4	5	6	7
MACRS 5-Year depreciation	20.00%	32.00%	19.20%	11.52%	11.52%	5.76%	0

Answer 1

a)

salvage value = 200,000

book value = 0

salvage value after tax = 200000(1 - 0.35) = 130000

year 0 cash flow is initial cash flow and year 10 is terminal

b)

c)

best case:

base case:

worst case:

formulas for part - b: