Rare Agri-Products Ltd. is considering a new project with a projected life  of seven  (7)years.  The  project  falls  under  the  government’s subsidy  program  for  encouraging  local  agricultural  products  and  is eligible  for  a  one-time  rebate  of  25%  on  any  initial  equipment installed  for  the  project.  The  initial  equipment  (IE)  will  cost $41,000,000. At the end of year 1, An additional equipment (AE) costing $3,500,000 will be needed at the end of year 3. At the end of seven (7)years, the original equipment, IE, will have no resale value but the supplementary equipment, AE, can be sold for $50,000. A working capital of $1,350,000 will be needed.The project is forecast to generate sales of agri-products over the seven years as follows:Year 170,000 unitsYear 2100,000 unitsYears 3-5250,000 unitsYears 6-7325,000 unitsA sale price of $150per unitfor the first two years is expected and then decline to $90 per unitthereafter as the newness of the product loses some sheen. The variable expenses will amount to 30% of sales revenue. Fixed cash operating expenses will amount to $1,100,000 per year.The company falls in the 25% tax categoryfor ordinary income and 40% tax category for capital gain.The initialequipment is depreciated as per the 7-year MACRS systemand the additional equipment is depreciated on a straight-line basis. In the event of a negative taxable income, the tax is computed as usual and is reported as a negative number, indicating a reduction in loss after tax.The initial financing of the project will be carried out as follows:-55% equity and 45% debt. The company paid $1.50 per share in the form of dividend thisyear, which is likely to increase at a rate of 3% per year for the near future.The current price of the company’s stock is $9.50per  share. The  bank  loan  is  likely  to  be  arranged  at  an interest rate of 13.5% p.a.   You are required to:   Compute the appropriate rate for discounting the cash flows of the project Compute the initial investment required Compute the earnings before taxes for years 1 through 7 Compute the earnings after taxes for years 1 through 7 Compute the OCF for years 1 through 7 Compute the Terminal cash flow Compute the FCF for years 1 through 7 Compute the NPV and IRR Should the project be accepted?

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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Rare Agri-Products Ltd. is considering a new project with a projected life  of seven  (7)years.  The  project  falls  under  the  government’s subsidy  program  for  encouraging  local  agricultural  products  and  is eligible  for  a  one-time  rebate  of  25%  on  any  initial  equipment installed  for  the  project.  The  initial  equipment  (IE)  will  cost $41,000,000. At the end of year 1, An additional equipment (AE) costing $3,500,000 will be needed at the end of year 3. At the end of seven (7)years, the original equipment, IE, will have no resale value but the supplementary equipment, AE, can be sold for $50,000. A working capital of $1,350,000 will be needed.The project is forecast to generate sales of agri-products over the seven years as follows:Year 170,000 unitsYear 2100,000 unitsYears 3-5250,000 unitsYears 6-7325,000 unitsA sale price of $150per unitfor the first two years is expected and then decline to $90 per unitthereafter as the newness of the product loses some sheen. The variable expenses will amount to 30% of sales revenue. Fixed cash operating expenses will amount to $1,100,000 per year.The company falls in the 25% tax categoryfor ordinary income and 40% tax category for capital gain.The initialequipment is depreciated as per the 7-year MACRS systemand the additional equipment is depreciated on a straight-line basis. In the event of a negative taxable income, the tax is computed as 
usual and is reported as a negative number, indicating a reduction in loss after tax.The initial financing of the project will be carried out as follows:-55% equity and 45% debt. The company paid $1.50 per share in the form of dividend thisyear, which is likely to increase at a rate of 3% per year for the near future.The current price of the company’s stock is $9.50per  share. The  bank  loan  is  likely  to  be  arranged  at  an interest rate of 13.5% p.a.

 

You are required to:
 
Compute the appropriate rate for discounting the cash flows of the project
Compute the initial investment required
Compute the earnings before taxes for years 1 through 7
Compute the earnings after taxes for years 1 through 7
Compute the OCF for years 1 through 7
Compute the Terminal cash flow
Compute the FCF for years 1 through 7
Compute the NPV and IRR
Should the project be accepted?
 
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