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TexMex Food Company is considering a new salsa whose data are shown below. The equipment to...

TexMex Food Company is considering a new salsa whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no new working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life.

However, this project would compete with other TexMex products and would reduce their pre-tax annual cash flows.

What is the project's NPV?

WACC 10.0%

Pre-tax cash flow reduction for other products (cannibalization) -$5,000

Investment cost (depreciable basis) $80,000

Straight-line deprec. rate 33.333%

Sales revenues, each year for 3 years $67,500

Annual operating costs (excl. deprec.) -$25,000

Tax rate 35.0%

Solutions

Expert Solution

Time line 0 1 2 3
Cost of new machine -80000
=Initial Investment outlay -80000
100.00%
Sales 62500 62500 62500
Profits Sales-variable cost 37500 37500 37500
-Depreciation Cost of equipment/no. of years -26666.6667 -26666.6667 -26666.6667 0 =Salvage Value
=Pretax cash flows 10833.33333 10833.33333 10833.33333
-taxes =(Pretax cash flows)*(1-tax) 7041.666667 7041.666667 7041.666667
+Depreciation 26666.66667 26666.66667 26666.66667
=after tax operating cash flow 33708.33 33708.33 33708.33
+Tax shield on salvage book value =Salvage value * tax rate 0
=Terminal year after tax cash flows 0
Total Cash flow for the period -80000 33708.33 33708.33 33708.33
Discount factor= (1+discount rate)^corresponding period 1 1.1 1.21 1.331
Discounted CF= Cashflow/discount factor -80000 30643.93636 27858.12397 25325.56724
NPV= Sum of discounted CF= 3827.63

jeff jeffy answered 2 years ago
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