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In: Finance

Sunshine Smoothies Company (SSC) manufactures and distributes smoothies. SSC is considering the development of a new...

Sunshine Smoothies Company (SSC) manufactures and distributes smoothies. SSC is considering the development of a new line of high-protein energy smoothies. SSC's CFO has collected the following information regarding the proposed project, which is expected to last 3 years:

  • The project can be operated at the company's Charleston plant, which is currently vacant.
  • The project will require that the company spend $4.1 million today (t = 0) to purchase additional equipment. For tax purposes the equipment will be depreciated on a straight-line basis over 5 years. Thus, the firm's annual depreciation expense is $4,100,000/5 = $820,000. The company plans to use the equipment for all 3 years of the project. At t = 3 (which is the project's last year of operation), the equipment is expected to be sold for $1,500,000 before taxes.
  • The project will require an increase in net operating working capital of $730,000 at t = 0. The cost of the working capital will be fully recovered at t = 3 (which is the project's last year of operation).
  • Expected high-protein energy smoothie sales are as follows:
    Year Sales
    1 $2,100,000
    2 8,000,000
    3 3,150,000
  • The project's annual operating costs (excluding depreciation) are expected to be 60% of sales.
  • The company's tax rate is 40%.
  • The company is extremely profitable; so if any losses are incurred from the high-protein energy smoothie project they can be used to partially offset taxes paid on the company's other projects. (That is, assume that if there are any tax credits related to this project they can be used in the year they occur.)
  • The project has a WACC = 10.0%.

What is the project's expected NPV and IRR? Round your answers to 2 decimal places. Do not round your intermediate calculations.

NPV $
IRR %

Solutions

Expert Solution

Time line 0 1 2 3
Cost of new machine -4100000
Initial working capital -730000
=Initial Investment outlay -4830000
100.00%
Sales 2100000 8000000 3150000
Profits Sales-variable cost 840000 3200000 1260000
-Depreciation Cost of equipment/no. of years -820000 -820000 -820000 1640000 =Salvage Value
=Pretax cash flows 20000 2380000 440000
-taxes =(Pretax cash flows)*(1-tax) 12000 1428000 264000
+Depreciation 820000 820000 820000
=after tax operating cash flow 832000 2248000 1084000
reversal of working capital 730000
+Proceeds from sale of equipment after tax =selling price* ( 1 -tax rate) 900000
+Tax shield on salvage book value =Salvage value * tax rate 656000
=Terminal year after tax cash flows 2286000
Total Cash flow for the period -4830000 832000 2248000 3370000
Discount factor= (1+discount rate)^corresponding period 1 1.1 1.21 1.331
Discounted CF= Cashflow/discount factor -4830000 756363.6 1857851 2531930.9
NPV= Sum of discounted CF= 316145.76
Total Cash flow for the period -4830000 832000 2248000 3370000
Discount factor= (1+discount rate)^corresponding period 1 1.130238 1.277439 1.4438106
Discounted CF= Cashflow/discount factor -4830000 736127.9 1759771 2334101.2
NPV= Sum of discounted CF= 1.50898E-05
IRR is discount rate at which NPV = 0 = 13.02%

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