Quantitative Problem: Sunshine Smoothies Company (SSC) manufactures and distribu
ID: 2751597 • 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 $4.5 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 $4,500,000/5 = $900,000. 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 $1,800,000 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 8,000,000 3 3,150,000 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%. What is the project's expected NPV and IRR? Round your answers to 2 decimal places. Do not round your intermediate calculations.
Explanation / Answer
The IRR is around 11.6% , where the NPV of the project would be zero.
Year 0 1 2 3 intial cost (4,500,000) working capital (730,000) Sale value of equipment 1,800,000 Sales 2,100,000 8,000,000 3,150,000 operating cost 60% 1,260,000 4,800,000 1,890,000 gross profit 840,000 3,200,000 1,260,000 Depreciation 900,000 900,000 900,000 Net profit (60,000) 2,300,000 360,000 Tax 40% (24,000) 920,000 144,000 Profit after tax (36,000) 1,380,000 216,000 ADD: Depreciation 900,000 900,000 900,000 Cashflow 864,000 2,280,000 1,116,000 Sale value of equipment - - 1,800,000 Working capital recovery - - 730,000 Total cashflow (5,230,000) 864,000 2,280,000 3,646,000 PV interest factor 1 0.9091 0.8264 0.7513 PV of cash flow (5,230,000) 785,455 1,884,298 2,739,294 NPV 179,046 Workings: intial cost 4,500,000 Useful life 5 Depreciation 900,000 Depreciation for 3 years 2,700,000 WDV end of 3 years 1,800,000 Sale 1,800,000 Profit -