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: Part (A) 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 D Expected inflation 8% Years 0 1 2 3 4 I. Investment Outlays Equipment cost ($450,000) Installation (38,000) CAPEX ($488,000) Increase in inventory (40,000) Increase in Account Payable 10,000 ΔNOWC ($30,000) II. Project Operating Cash Flows Unit sales 195,000 195,000 195,000 195,000 Price per unit $ 1.728 $ 1.866 x x Total revenues 336,960 363,917 x 424,473 Operating costs (w/o deprn) x x x x Depreciation x x x x Total costs x x x x EBIT (Operating income) x x x x Taxes on operating income x x x x EBIT (1 ‒ T) = Aafter tax operating income x x x x Add back depreciation x x x x EBIT (1 ‒ T) + DEP x x x x III. Terminal Year Cash Flows Salvage value x Tax on salvage value x After-tax salvage value x Recovery of NOWC x Project Free Cash Flows = ($518,000) $200,572 x x $271,980 EBIT(1-T) + DEP - CAPEX - ΔNOWC

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: Part (A) 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 D Expected inflation 8% Years 0 1 2 3 4 I. Investment Outlays Equipment cost ($450,000) Installation (38,000) CAPEX ($488,000) Increase in inventory (40,000) Increase in Account Payable 10,000 ΔNOWC ($30,000) II. Project Operating Cash Flows Unit sales 195,000 195,000 195,000 195,000 Price per unit $ 1.728 $ 1.866 x x Total revenues 336,960 363,917 x 424,473 Operating costs (w/o deprn) x x x x Depreciation x x x x Total costs x x x x EBIT (Operating income) x x x x Taxes on operating income x x x x EBIT (1 ‒ T) = Aafter tax operating income x x x x Add back depreciation x x x x EBIT (1 ‒ T) + DEP x x x x III. Terminal Year Cash Flows Salvage value x Tax on salvage value x After-tax salvage value x Recovery of NOWC x Project Free Cash Flows = ($518,000) $200,572 x x $271,980 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

Problem 1PS

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Related questions

Question

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:
Part (A)
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.