QUESTION 2 I. A juice manufacturer conducted a marketing study three years ago t
ID: 2658351 • Letter: Q
Question
QUESTION 2 I. A juice manufacturer conducted a marketing study three years ago to determine the consumers preferences for different type of juices including organic juices. This study was very extensive and detrimental in their decision to start a new organic juice division today. It cost them $1,000,000 to perform this study The company is considering introducing organic juices. The company will add a new assembly line in order to the organic juices separate from their existing assembly line for regular non-organic juices prodace The project has an anticipated life of 4 years The new assembly line has a cost of $1, 00,000 It will require $$00,000 to customize it to the new specifications for organic juice production, and $100,000 for transportation and shipping to the company's plant. The new machine falls into 5-years MACRS category (20%, 32%, 19.2%, l 1.52%, 11.52% and 5.76%). The organic juice production will require inventories to increase by $1,000,000 at time 0; in addition, accounts payables and accruals will increase by $450,000 and S150,000 respectively The organic juice is expected to generate sales revenue of $700,000 million the first year. The revenue is expected to increase by $300,000 every year. Each year the operating costs (excluding depreciation) are expected to equal so percent of sales revenue. In order to do this expansion, the company will borrow $3 million. The annual interest expense on this borrowing $400,000. The organic juice is expected to decrease the company's existing non-organic juice sale by $350,000 per year before tax basis. The company can sell the new machine at the end of 4 years for $50,000 in the market. The company's cost of capital is 12 percent. The company's tax rate is 40 percent. What is the CFI to be used in NPV calculations?Explanation / Answer
The value of CF1 to be used in NPV calculation is determined as below:
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Notes:
1) The information provided in the question with respect to sales revenue of $700,000 million doesn't seem to be correct. Therefore, the revenue from organic juices is taken as $700,000 only.
2) Operational costs are taken as 50% of revenue from sale of organic juices.
Sales Revenue from Organic Juices 700,000 Less Operational Costs (700,000*50%) 350,000 Decrease in Sales of Non-Organic Juices 350,000 Depreciation [(1,500,000 + 500,000 + 100,000)*20%] 420,000 EBIT -420,000 Less Taxes -168,000 EAT -252,000 Add Depreciation 420,000 Cash Flow Year 1 to be Used in NPV Calculation $168,000