Question

Quantitative Problem: 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 $3.8 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 $3,800,000/5 = $760,000. 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 $1,450,000 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	$2,600,000
  2	7,400,000
  3	3,800,000

• 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	%

Answer 1

Time line		0	1	2	3
Cost of new machine		-3800000
Initial working capital		-730000
=Initial Investment outlay		-4530000
						100.00%
Sales			2600000	7400000	3800000
Profits	Sales-variable cost		1040000	2960000	1520000
-Depreciation	Cost of equipment/no. of years		-760000	-760000	-760000	1520000
=Pretax cash flows			280000	2200000	760000
-taxes	=(Pretax cash flows)*(1-tax)		168000	1320000	456000
+Depreciation			760000	760000	760000
=after tax operating cash flow			928000	2080000	1216000
reversal of working capital					730000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				870000
+Tax shield on salvage book value	=Salvage value * tax rate				608000
=Terminal year after tax cash flows					2208000
Total Cash flow for the period		-4530000	928000	2080000	3424000
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331
Discounted CF=	Cashflow/discount factor	-4530000	843636.4	1719008	2572501.9
NPV=	Sum of discounted CF=	605146.51

Total Cash flow for the period		-4530000	928000	2080000	3424000
Discount factor=	(1+discount rate)^corresponding period	1	1.161042	1.348018	1.5651055
Discounted CF=	Cashflow/discount factor	-4530000	799282.1	1543006	2187712
NPV=	Sum of discounted CF=	0.000509266
IRR is discount rate at which NPV = 0 =	16.10%