Allied Food Products is considering expanding into the fruit juice business with a new fresh lemon juice product. Assume that you were recently hired as assistant to the director of capital budgeting, and you must evaluate the new project. The lemon juice would be produced in an unused building adjacent to Allied’s Fort Myers plant; Allied owns the building, which is fully depreciated. The required equipment would cost $450,000, plus an additional $38,000 for shipping and installation. In addition, inventories would rise by $40,000, while accounts payable would increase by $10,000. All of these costs would be incurred at t = 0. By a special ruling, the machinery could be depreciated under the MACRS system as 4-year property. The applicable depreciation rates are 40%, 30%, 20%, and 10%. The project is expected to operate for 4 years, at which time it will be terminated. The cash inflows are assumed to begin 1 year after the project is undertaken (t = 1), and to continue out to t = 4. At the end of the project’s life (t = 4), the equipment is expected to have a salvage value of $45,000. Unit sales are expected to total 195,000 units per year, and the expected sales price is $1.60 per unit. Cash operating costs for the project (total operating costs less depreciation) are expected to total 40% of dollar sales. Allied’s tax rate is 23%, and its WACC is 12%. Tentatively, the lemon juice project is
Allied Food Products is considering expanding into the fruit juice business with a new fresh lemon juice
product. Assume that you were recently hired as assistant to the director of capital budgeting, and you
must evaluate the new project.
The lemon juice would be produced in an unused building adjacent to Allied’s Fort Myers plant; Allied
owns the building, which is fully
additional $38,000 for shipping and installation. In addition, inventories would rise by $40,000, while
accounts payable would increase by $10,000. All of these costs would be incurred at t = 0. By a special
ruling, the machinery could be depreciated under the MACRS system as 4-year property. The applicable
depreciation rates are 40%, 30%, 20%, and 10%.
The project is expected to operate for 4 years, at which time it will be terminated. The
assumed to begin 1 year after the project is undertaken (t = 1), and to continue out to t = 4. At the end
of the project’s life (t = 4), the equipment is expected to have a salvage value of $45,000.
Unit sales are expected to total 195,000 units per year, and the expected sales price is $1.60 per unit.
Cash operating costs for the project (total operating costs less depreciation) are expected to total 40%
of dollar sales. Allied’s tax rate is 23%, and its WACC is 12%. Tentatively, the lemon juice project is
assumed to be of equal risk to Allied’s other assets.
Allied has a standard form that is used in the capital budgeting process. (See Table 1) Part of the table
has been completed, but you must replace the blanks with the missing numbers (marked with x).
Complete the table using the following steps:
1. Fill in the blanks under Year 0 for the initial investment outlays: Capital Expenditures (CAPEX)
and change in Net Operating Working Capital (ΔNOWC).
2. Complete the table for unit sales, sales price, total revenues, and operating costs excluding
depreciation.
3. Complete the depreciation data.
4. Complete the table down to after-tax operating income and then down to the project’s
operating cash flows, EBIT(1 − T) + DEP.
5. Fill in the blanks under Year 4 for the terminal cash flows and complete the project free cash
flow line.
| Case: Allied Food Products | ||||||||||||
| PART A | ||||||||||||
|
|
|
|
|
|
||||||||
| 0 | 1 | 2 | 3 | 4 | ||||||||
| I. Investment Outlays | ||||||||||||
| Equipment cost | x | |||||||||||
| Shipping and Installation | x | |||||||||||
| CAPEX | x | |||||||||||
| Increase in inventory | x | |||||||||||
| Increase in Accounts Payable | x | |||||||||||
| ΔNOWC | x | |||||||||||
| II. Project Operating Cash Flows | ||||||||||||
| Unit sales | x | 195,000 | x | x | ||||||||
| Price per unit | $1.60 | $1.60 | $1.60 | $1.60 | ||||||||
| Total revenues | x | x | x | $312,000 | ||||||||
| Operating costs (w/o deprn) | x | 124,800 | x | x | ||||||||
| Depreciation | x | x | 97,600 | 48,800 | ||||||||
| Total costs | $320,000 | $271,200 | x | x | ||||||||
| EBIT (Operating income) | x | x | $89,600 | x | ||||||||
| Taxes on operating income | (1,840) | x | x | 31,832 | ||||||||
| EBIT (1 ‒ T) = After Tax operating income | x | x | $68,992 | x | ||||||||
| Add back depreciation | 195,200 | x | 97,600 | 48,800 | ||||||||
| EBIT (1 ‒ T) + DEP | $0 | $189,040 | x | x | $155,368 | |||||||
| III. Project Termination Cash Flows | ||||||||||||
| Salvage value | $45,000 | |||||||||||
| Tax on salvage value | (10,350) | |||||||||||
| After-tax salvage value | 34,650 | |||||||||||
| ΔNOWC = Recovery of NOWC | $30,000 | |||||||||||
| Project |
($518,000) | x | x | x | $220,018 | |||||||
| EBIT(1-T) + DEP - CAPEX - ΔNOWC | ||||||||||||
Trending now
This is a popular solution!
Step by step
Solved in 3 steps with 6 images
