Coca-Cola is considering jumping on the pomegranate bandwagon by producing Poma-
ID: 2779094 • Letter: C
Question
Coca-Cola is considering jumping on the pomegranate bandwagon by producing Poma-Cola and Pomegranate Sprite carbonated beverages in 2016 (t=1). New production equipment and facilities costing $30 million will be required in 2015 (t =0) and fall into the 5-year straight-line depreciation class. Additional net working capital of $5 million will also be needed in 2015. Here are sales projections for the proposed projects.
Year Expected New Pomegranate Sales
2016 $22 million
2017 $30 million
2018 $25 million
2019 $20 million
Projected operating costs (other than depreciation) are 73% of sales for the new beverages. However, Coca-cola estimates that projected sales for other carbonated beverages will fall $5 million in 2016, $9 million in 2017, $7 million in 2018, and $4 million in 2019 if they introduce the new beverages. Projected operating costs for these existing beverages are 68% of sales. At the end of 2019, the project will end and the production equipment and facilities could be sold for an estimated $10 million.
Coca-Cola’s marginal tax rate is 40% and this is an average risk project for the company giving the project a WACC of 9%. Answer the following.
1. What is the initial cost of the project?
2. What are the expected operating cash flows for 2016 thru 2019?
3. What is the expected end of project termination cash flow at the end of 2019?
4. Calculate the NPV and IRR for the proposed project.
5. Should Coca-Cola go ahead with this project? Explain your answer.
Explanation / Answer
1. What is the initial cost of the project?
Initial cost of the project = - new production Equipment - investment in working capital
Initial cost of the project = -30 - 5
Initial cost of the project = - 35 Milliion
2. What are the expected operating cash flows for 2016 thru 2019?
Expected operating cash flows for 2016 = (Expected New Pomegranate Sales*(1-operating cost%))*(1-tax rate) - ( Current Sale lost *(1-operating cost%))*(1-tax rate + Annual Depreciation*tax rate
Expected operating cash flows for 2016 = (22*(1-73%))*(1-40%) - (5*(1-68%))*(1-40%) + 30/5*40%
Expected operating cash flows for 2016 = $ 5.004 Million
Expected operating cash flows for 2017 = (Expected New Pomegranate Sales*(1-operating cost%))*(1-tax rate) - ( Current Sale lost *(1-operating cost%))*(1-tax rate + Annual Depreciation*tax rate
Expected operating cash flows for 2017 = (30*(1-73%))*(1-40%) - (9*(1-68%))*(1-40%) + 30/5*40%
Expected operating cash flows for 2017 = $ 5.532 Million
Expected operating cash flows for 2018 = (Expected New Pomegranate Sales*(1-operating cost%))*(1-tax rate) - ( Current Sale lost *(1-operating cost%))*(1-tax rate + Annual Depreciation*tax rate
Expected operating cash flows for 2018 = (25*(1-73%))*(1-40%) - (7*(1-68%))*(1-40%) + 30/5*40%
Expected operating cash flows for 2018 = $ 5.106 Million
Expected operating cash flows for 2019 = (Expected New Pomegranate Sales*(1-operating cost%))*(1-tax rate) - ( Current Sale lost *(1-operating cost%))*(1-tax rate + Annual Depreciation*tax rate
Expected operating cash flows for 2019 = (20*(1-73%))*(1-40%) - (4*(1-68%))*(1-40%) + 30/5*40%
Expected operating cash flows for 2019 = $ 4.872 Million
3. What is the expected end of project termination cash flow at the end of 2019?
Book Value of equipment at the end of 2019 = 30 - 30*4/5
Book Value of equipment at the end of 2019 = $ 6 Million
Post tax salavge value = Sale Value - Tax rate*(Sale value -Book Value)
Post tax salavge value = 10 - 40%*(10-6)
Post tax salavge value = $ 8.40 Million
Expected end of project termination cash flow at the end of 2019 = Post tax salavge value + working capital recovered
Expected end of project termination cash flow at the end of 2019 = 8.40 + 5
Expected end of project termination cash flow at the end of 2019 = $ 13.40 Million
4. Calculate the NPV and IRR for the proposed project.
NPV = - 35 + 5.004/1.09 + 5.532/1.09^2 + 5.106/1.09^3 + 4.872/1.09^4+ 13.4/1.09^4
NPV = -8.658863 Million
IRR = irr({-35.5.004,5.532,5.106,18.272})
IRR = -7.99%
5. Should Coca-Cola go ahead with this project? Explain your answer.
No the Coca-Cola should not go ahead with this project because NPV is negative & IRR is lower than cost of capital, The project is not viable