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 assumed to be of equal risk to Allied’s other assets. You have been asked to evaluate the project and to make a recommendation as to whether it should be accepted or rejected. To guide you in your analysis, your boss gave you the following set of tasks/questions: 1. Fill in the blanks under Year 0 for the initial investment outlays: Capital Expenditures (CAPEX) and change in Net Operating Working Capital (ΔNOWC). Case: Allied Food Products                 PART A                       Years           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 Free Cash Flows = ($518,000)   x     x     x   $220,018   EBIT(1-T) + DEP - CAPEX - ΔNOWC

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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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
assumed to be of equal risk to Allied’s other assets.
You have been asked to evaluate the project and to make a recommendation as to whether it should be
accepted or rejected. To guide you in your analysis, your boss gave you the following set of
tasks/questions:

1. Fill in the blanks under Year 0 for the initial investment outlays: Capital Expenditures (CAPEX)
and change in Net Operating Working Capital (ΔNOWC).

Case: Allied Food Products
               
PART A              
   
 
 
Years
 
 
 
    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 Free Cash Flows = ($518,000)   x     x     x   $220,018  
EBIT(1-T) + DEP - CAPEX - ΔNOWC            
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