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 $ 102,000. 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 $ 1.2 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 $ 600,000. ​ 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 $ 4.6 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, working and answers (highlighted in yellow)

The NPV of this Project is 1382194.36

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;