Quantitative Problem: Sunshine Smoothies Company (SSC) manufactures and distribu
ID: 2713507 • Letter: Q
Question
Quantitative Problem: Sunshine Smoothies Company (SSC) manufactures and distributes smoothies. SSC is considering the development of a new line of high-protein energy smoothies. SSC's CFO has collected the following information regarding the proposed project, which is expected to last 3 years: The project can be operated at the company's Charleston plant, which is currently vacant. The project will require that the company spend $3.99 million today (t = 0) to purchase additional equipment. For tax purposes the equipment will be depreciated on a straight-line basis over 5 years. Thus, the firm's annual depreciation expense is $3,990,000/5 = $798,000. The company plans to use the equipment for all 3 years of the project. At t = 3 (which is the project's last year of operation), the equipment is expected to be sold for $1,700,000 before taxes. The project will require an increase in net operating working capital of $730,000 at t = 0. The cost of the working capital will be fully recovered at t = 3 (which is the project's last year of operation). Expected high-protein energy smoothie sales are as follows:
Year Sales
1 $2,100,000
2 $7,900,000
3 $3,200,000
The project's annual operating costs (excluding depreciation) are expected to be 60% of sales. The company's tax rate is 40%. The company is extremely profitable; so if any losses are incurred from the high-protein energy smoothie project they can be used to partially offset taxes paid on the company's other projects. (That is, assume that if there are any tax credits related to this project they can be used in the year they occur.) The project has a WACC = 10.0%.
a.)What is the project's expected NPV and b.) what is the project's IRR? Round your answers to 2 decimal places. Do not round your intermediate calculations.
Explanation / Answer
Year Sales Operating Costs Depreciation Profits before Tax Net Profit Taxes Impact post Taxes 1 $2,100,000 1260000 798000 42000 16800 25200 2 $7,900,000 4740000 798000 2362000 944800 1417200 3 $3,200,000 1920000 798000 482000 192800 289200 a) NPV is calculated considering the following factors : $ Initial Investment 4720000 Investment for Year 1 4720000 Yearly profits made Year 1 25200 Year 2 1417200 Year 3 289200 Recovery at the end of year 3 Working Capital 730000 Salvage Value of machinery 1020000 40% tax impact considered on sale value of 1,700,000 Cost of capital 10% Hence, the NPV is worked out as -19,78,755.84 IRR cannot be worked out as the NPV is a substantial negative amount.