Respond to the following scenario with your thoughts, ideas, and comments. Be substantive and clear, and use research to reinforce your ideas.
Over lunch, you and Mary meet to discuss next steps with the expansion project.
“Do we have everything we need on sales and costs?” you ask. ”It must be time to compute the net present value (NPV) and internal rate of return (IRR) of the Apix expansion project.”
“We have the data from James and Luke regarding projected sales and costs, respectively, for the food packaging project,” says Mary. “It is feasible to project that we will receive a tax break from this implementation. I have information from our audit firm that indicates that future depreciation methods for taxes will be straight-line; however, the corporate rates will be reduced to 35% as we assumed in our weighted average cost of capital (WACC) calculation.”
“That sounds good,” you say.
“Right,” says Mary. “You can use a WACC of 10% for the computation of the NPV and comparison for IRR.”
“I’ve got the information I need from Luke and James,” you say. “Does this look right to you? Here’s what they gave me,” you say, as you hand a sheet of paper to Mary.“Let’s look at this now while we’re together,” she says.
The information you hand to Mary shows the following:
- Initial investment outlay of $30 million, consisting of $25 million for equipment and $5 million for net working capital (NWC) (plastic substrate and ink inventory); NWC recoverable in terminal year
- Project and equipment life: 5 years
- Sales: $25 million per year for five years
- Assume gross margin of 60% (exclusive of depreciation)
- Depreciation: Straight-line for tax purposes
- Selling, general, and administrative expenses: 10% of sales
- Tax rate: 35%
You continue your conversation.
“It looks good,” says Mary. “Use this information from Luke and James to compute the cash flows for the project.”
“No problem,” you say.
“Then, compute NPV and IRR of the project using the Excel spreadsheet I sent earlier today,” says Mary. “Use the IRR financial function for the computation of IRR.”
“Okay,” you say. “I’ll submit my Excel file showing the computation of cash flows, NPV, and IRR by the end of week so you can look at it over the weekend.”
“Thanks,” says Mary.
Complete the above worksheet for this assignment.
Points Possible 100
Download the Excel Spreadsheet from the Assignment List.
Fill in the Cash flow for each year.
With the following information:
Initial investment outlay of $30 million, consisting of $25 million for equipment and $5 million for net working capital (NWC) (plastic substrate and ink inventory); NWC recoverable in terminal year
Project and equipment life: 5 years
Sales: $25 million per year for five years
Assume gross margin of 60% (exclusive of depreciation)
Depreciation: Straight-line for tax purposes
Selling, general, and administrative expenses: 10% of sales
Tax rate: 35%
Use a WACC of 10%.
Compute, cash flows. The NPV and IRR of the project will be automatically calculated. If it does not you have made a mistake.
Submit the Excel Spreadsheet.
Complete your Intellipath by Sunday
Intellipath Unit: Investment Valuation and Decision Making
Points Possible: 125
Try to complete your Determine Knowledge by Wednesday.
If you have problems, flag the question in Intellipath.
If you have questions, DO NOT use the Intellipath message system. Email me. Try to include a screen shot of the question.
Your path will only consist of learning nodes that you need to work on and is individualized for you, so if you have difficulty with a question you must flag the question in Intellipath.
NWC Recapture is in the fifth year. NWC is given in task list.
The discount rate (Cost of Capital) is given.
A hint: the numbers will look the same for the first 4 years,. In Year 5 it will be different due to NWC recovery.
Initial cash flow for year 0 is given.
You must put a cash flow for year 0 into your spreadsheet. It is given as initial outlay. It should be inputed as a negative quantity.
Sales are given (This is also called Revenue)
Gross margin is given.
Calculate: COGS (You must find the equation that gives you COGS from gross margin and sales (revenue)). Do a search on “COGS, Margin, Sales”. You must determine what is COGS.
Calculate SGA expense.
Calculate yearly depreciation, straight line for tax purposes, look this up. There is no salvage value.
Subtract COGS, SGA and depreciation from Sales (Revenue).
This gives EBT, Earnings Before Taxes, also called Operating Income.
Calculate Taxes on basis of EBT, tax rate is given.
Subtract this from EBT (Operating Income).
This gives Net Income.
Add Depreciation back in to Net Income. This gives cashflow.
Add NWC recovery to Net Income in the 5th year.
This gives a Cashflow for each year.
You should enter a cashflow for each year into your spreadsheet.
Enter year 0 cash flow with a negative number: Cell B9
Enter year 1-4 (these should be the same): C9 –F9.
Enter year 5 cash flow after you have added back NWC: G9.
The NPV and IRR should calculate automatically. If it does not you have made a mistake.
To calculate depreciation:
By “straight-line,” we mean that the depreciation deduction is the same every year. By “written down to zero,” we mean that the asset is assumed to have no value at the end of five years, that is no salvage value.
Here is an online tutorial that may be of help for NWC:
Here is another: