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 required equipment would cost $450,000, plus an additional $38,000 for shipping and installation. In addition, inventories would rise by $40,000, while accounts payable would increase by $10,000. All of these costs would be incurred at t = 0. By a special ruling, the machinery could be depreciated under the MACRS system as 4-year property. The applicable depreciation rates are 40%, 30%, 20%, and 10%. 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 (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 $45,000. Unit sales are expected to total 195,000 units per year, and the expected sales price is $1.60 per unit. Cash operating costs for the project (total operating costs less depreciation) are expected to total 40% of dollar sales. Allied’s tax rate is 23%, and its WACC is 12%. 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. To guide you in your analysis, your boss gave you the following set of tasks/questions: Complete the table down to after-tax operating income and then down to the project’s operating cash flows, EBIT(1 − T) + DEP. Fill in the blanks under Year 4 for the terminal cash flows and complete the project free cash flow line. Case: Allied Food Products PART A Years 0 1 2 3 4 I. Investment Outlays Equipment cost x Shipping and Installation x CAPEX x Increase in inventory x Increase in Accounts Payable x ΔNOWC x II. Project Operating Cash Flows Unit sales x 195,000 x x Price per unit $1.60 $1.60 $1.60 $1.60 Total revenues x x x $312,000 Operating costs (w/o deprn) x 124,800 x x Depreciation x x 97,600 48,800 Total costs $320,000 $271,200 x x EBIT (Operating income) x x $89,600 x Taxes on operating income (1,840) x x 31,832 EBIT (1 ‒ T) = After Tax operating income x x $68,992 x Add back depreciation 195,200 x 97,600 48,800 EBIT (1 ‒ T) + DEP $0 $189,040 x x $155,368 III. Project Termination Cash Flows Salvage value $45,000 Tax on salvage value (10,350) After-tax salvage value 34,650 ΔNOWC = Recovery of NOWC $30,000 Project Free Cash Flows = ($518,000) x x x $220,018 EBIT(1-T) + DEP - CAPEX - ΔNOWC

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 required equipment would cost $450,000, plus an additional $38,000 for shipping and installation. In addition, inventories would rise by $40,000, while accounts payable would increase by $10,000. All of these costs would be incurred at t = 0. By a special ruling, the machinery could be depreciated under the MACRS system as 4-year property. The applicable depreciation rates are 40%, 30%, 20%, and 10%. 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 (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 $45,000. Unit sales are expected to total 195,000 units per year, and the expected sales price is $1.60 per unit. Cash operating costs for the project (total operating costs less depreciation) are expected to total 40% of dollar sales. Allied’s tax rate is 23%, and its WACC is 12%. 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. To guide you in your analysis, your boss gave you the following set of tasks/questions: Complete the table down to after-tax operating income and then down to the project’s operating cash flows, EBIT(1 − T) + DEP. Fill in the blanks under Year 4 for the terminal cash flows and complete the project free cash flow line. Case: Allied Food Products PART A Years 0 1 2 3 4 I. Investment Outlays Equipment cost x Shipping and Installation x CAPEX x Increase in inventory x Increase in Accounts Payable x ΔNOWC x II. Project Operating Cash Flows Unit sales x 195,000 x x Price per unit $1.60 $1.60 $1.60 $1.60 Total revenues x x x $312,000 Operating costs (w/o deprn) x 124,800 x x Depreciation x x 97,600 48,800 Total costs $320,000 $271,200 x x EBIT (Operating income) x x $89,600 x Taxes on operating income (1,840) x x 31,832 EBIT (1 ‒ T) = After Tax operating income x x $68,992 x Add back depreciation 195,200 x 97,600 48,800 EBIT (1 ‒ T) + DEP $0 $189,040 x x $155,368 III. Project Termination Cash Flows Salvage value $45,000 Tax on salvage value (10,350) After-tax salvage value 34,650 ΔNOWC = Recovery of NOWC $30,000 Project Free Cash Flows = ($518,000) x x x $220,018 EBIT(1-T) + DEP - CAPEX - ΔNOWC

Corporate Fin Focused Approach

5th Edition

ISBN:9781285660516

Author:EHRHARDT

Publisher:EHRHARDT

Chapter11: Cash Flow Estimation And Risk Analysis

Section: Chapter Questions

Problem 1eM

See similar textbooks