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 $2m and which it currently rents out for $140,000. Rental rates are not expected to change going forward. In addition to using the warehouse, the project requires an up-front investment into machines and other equipment of $1.5m. 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 $540,000. Finally, the project requires an initial investment into net working capital equal to 10% of predicted first-year sales. Subsequently, net working capital is 10% of the predicted sales over the following year. Sales of protein bars are expected to be $5m in the first year and to stay constant for eight years. Total manufacturing costs and operating expenses (excluding depreciation) are 80% of sales, and profits are taxed at 30%. 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? (assume the warehouse can be rented out again for $120,000 after 8 years; assume the NWC can be fully recovered at book value after 8 years)
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 $2m and which it currently
rents out for $140,000. Rental rates are not expected to change going forward. In
addition to using the warehouse, the project requires an up-front investment into
machines and other equipment of $1.5m. This investment can be fully
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 $540,000. Finally, the project requires an initial investment into net
working capital equal to 10% of predicted first-year sales. Subsequently, net
working capital is 10% of the predicted sales over the following year. Sales of
protein bars are expected to be $5m in the first year and to stay constant for eight
years. Total
are 80% of sales, and profits are taxed at 30%.
a. What are the
b. If the cost of capital is 15%, what is the
(assume the warehouse can be rented out again for $120,000 after 8 years; assume
the NWC can be fully recovered at book value after 8 years)
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