IM DZ Chocolate Factory has just completed a 2 year $1.2 million market study re
ID: 2615084 • Letter: I
Question
IM DZ Chocolate Factory has just completed a 2 year $1.2 million market study related to the introduction of a new gourmet chocolate bar. Based on the results of the marketing survey, the company will be able to sell $382.4M in product. The increased variable costs are estimated at $320.0M and fixed costs are estimated to be an additional $28.4 million per year. The firm has a tax rate of 40% and projects require a 16 percent rate of return. The project will require an investment of $85.5 million to build the production facilities on land the company currently owns. The company will spend $16.3 million in net working capital and the land has a current market value of $4.5M. The million in production facilities belong in CCA class that has a CCA rate of 15%. The asset class will remain open at the end of the project. The project is expected to last 10 years and the assets will be sold for an estimated $20.4 million (excluding the land). The company will incur a one-time fully tax deductible expense of $3.3 million at time 0.
1. Calculate the initial investment for the project (I0). (3 marks)
2. Calculate the present value of the cash flows after tax from the operations. (3 marks)
3. Calculate the present value of the CCA tax shield. (3 marks)
4. Calculate the present value of the terminal cash flows. (3 marks)
5. Calculate the NPV of the project and explain your decision. (2 marks) 6. Is the IRR greater than, equal to or less than the required rate of return of 16 percent? Calculate the IRR. (A guess with no explanation is worth 0) (6 marks)
Explanation / Answer
IRR is greater than 16 %
1 Initial investment of the project production facilities on the land 85.5 million $ Net working capital 16.3 million $ One time tax deductable expenses 3.3 million $ Total investment 105.1 2 PV of cash flows after tax from operations Sales Variable cost Fixed cost Net income After tax *.6 PV @ 16 % Year 1 382.4 320 28 34 20.40 17.59 Year 2 382.4 320 28 34 20.40 15.16 Year 3 382.4 320 28 34 20.40 13.07 Year 4 382.4 320 28 34 20.40 11.27 Year 5 382.4 320 28 34 20.40 9.71 Year 6 382.4 320 28 34 20.40 8.37 Year 7 382.4 320 28 34 20.40 7.22 Year 8 382.4 320 28 34 20.40 6.22 Year 9 382.4 320 28 34 20.40 5.36 Year 10 382.4 320 28 34 20.40 4.62 98.60 3 PV of the CCA tax shields 16% Cost of asset Dep @ 15 % Tax Shield @ 40 % PV @ 16 % Year 1 85.5 13 5.13 4.42 Year 2 73 11 4.36 3.24 Year 3 62 9 3.71 2.37 Year 4 53 8 3.15 1.74 Year 5 45 7 2.68 1.27 Year 6 38 6 2.28 0.93 Year 7 32 5 1.93 0.68 Year 8 27 4 1.64 0.50 Year 9 23 3 1.40 0.37 Year 10 20 3 1.19 0.27 PV of all tax shields 15.81 4 PV of the assets sold at 10 year @ 16 % 20.4 20.4 4.62 (Terminal cash flows ) 5 NPV of the project = - initial investment + pv of all cash flows + terminal cash flows : = -105.1 + 98.6 + 4.62 + 15.81 + (3.3*.40) 15.25 million $IRR is greater than 16 %