Arnold Inc. is considering a proposal to manufacture​ high-end protein bars used as food supplements by body builders. The project requires use of an existing​ warehouse, which the firm acquired three years ago for $1 million and which it currently rents out for $108,000. Rental rates are not expected to change going forward. In addition to using the​ warehouse, the project requires an upfront investment into machines and other equipment of $1.5 million. This investment can be fully depreciated​ straight-line over the next 10 years for tax purposes. ​ However, Arnold Inc. expects to terminate the project at the end of eight years and to sell the machines and equipment for $432,000. ​ Finally, the project requires an initial investment into net working capital equal to 10 percent of predicted​ first-year sales.​ Subsequently, net working capital is 10 percent of the predicted sales over the following year. Sales of protein bars are expected to be $4.8 million in the first year and to stay constant for eight years. Total manufacturing costs and operating expenses​ (excluding depreciation) are 80 percent of​ sales, and profits are taxed at 30 percent. a. What are the free cash flows of the​ project? b. If the cost of capital is 15%​, what is the NPV of the​ project?

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
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Arnold Inc. is considering a proposal to manufacture​ high-end protein bars used as food supplements by body builders. The project requires use of an existing​ warehouse, which the firm acquired three years ago for
$1
million and which it currently rents out for
$108,000.
Rental rates are not expected to change going forward. In addition to using the​ warehouse, the project requires an upfront investment into machines and other equipment of
$1.5
million. This investment can be fully depreciated​ straight-line over the next 10 years for tax purposes. ​ However, Arnold Inc. expects to terminate the project at the end of eight years and to sell the machines and equipment for
$432,000.
​ Finally, the project requires an initial investment into net working capital equal to 10 percent of predicted​ first-year sales.​ Subsequently, net working capital is 10 percent of the predicted sales over the following year. Sales of protein bars are expected to be
$4.8
million in the first year and to stay constant for eight years. Total manufacturing costs and operating expenses​ (excluding depreciation) are 80 percent of​ sales, and profits are taxed at 30 percent.
a. What are the free cash flows of the​ project?
b. If the cost of capital is
15%​,
what is the NPV of the​ project?
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