CAPITAL BUDGETING AND CASH FLOW ESTIMATION Allied Food Products is considering expanding into the fruit juice business with a new fresh lemon juice product. Assume that you were recently hired as assistant to the director of capital budgeting, and you must evaluate the new project.
The lemon juice would be produced in an unused building adjacent to Allied’s Fort Myers plant; Allied owns the building, which is fully depreciated. The purchase price of the required equipment is $280,000, including shipping and installation costs, and the equipment is eligible for 100% bonus depreciation at the time of purchase. In addition, inventories would rise by $25,000, while accounts payable would increase by $5,000. All of these costs would be incurred at t = 0.
The project is expected to operate for 4 years, at which time it will be terminated. The cash inflows are assumed to begin 1 year after the project is undertaken, or at t = 1, and to continue out to t = 4. At the end of the project’s life (t = 4), the equipment is expected to have a salvage value of $25,000.
Unit sales are expected to total 100,000 units per year, and the expected sales price is $2.00 per unit. Cash operating costs for the project are expected to total 60% of dollar sales. Allied’s tax rate is 25%, and its WACC is 10%. Tentatively, the lemon juice project is assumed to be of equal risk to Allied’s other assets.
You have been asked to evaluate the project and to make a recommendation as to whether it should be accepted or rejected. Complete the table.
Extracted text: End of Year: 1. Investment Outlays САРЕХ X (1 — Т) Increase in inventory Increase in accounts payable ANOWC II. Project Operating Cash Flows Unit sales (thousands) 100 Price/unit 2.00 $ 2.00 Total revenues $ 200.0 Operating costs $ 120.0 Depreciation: 100% Bonus Depreciation in Year 0 0.0 0.0 0.0 0.0 Total costs $ 120.0 $ 120.0 EBIT (or operating income) $ 80.0 Taxes on operating income (25%) EBIT (1 – T) = After-tax operating income 20.0 20.0 $ 60.0 Add back depreciation 0.0 0.0 ЕВIT (1 — Т) + DEP 0.0 $ 60.0 $ 60.0 II. Project Termination Cash Flows Salvage value (taxed as ordinary income) Tax on salvage value (25%) After-tax salvage value ANOWC = Recovery of NOWC Project free cash flows = ЕВITI - T) + DEP - САРЕХ — ANOWC ($230.0) $ 98.8 IV. Results NPV = IRR = MIRR = || ||