Hawaiian Coconut Milkshakes
Inc. is considering the following project. They would like to expand
in the pineapple branch as well. The firm has paid $100,000 to a consultant
in order to find out more about the available projects and possibilities.
The marketing department has done extensive consumer research on the potential
demand for the new shakes. The total costs for this research has been $75,000.
Based on this research, you are now considering opening up a Pineapple
Juice division in the firm. The expected sales for this project are $1,600,000
per year for the next 3 years. Accepting the project would mean that you
will use one of your currently owned empty storage units. This storage
unit consists of a 12,000 square feet building, for which you paid $50,000
in 1985. This storage unit has been fully depreciated and has a current
market value of $60,000. Accepting the project would also mean that your
current coconut shake sales are affected. In fact, you expect to see your
current revenues from coconut shakes of $1 million each year increase by
10% because of the pineapple project. Manufacturing plant and equipment
for this project (other than the storage unit) would cost $900,000 and
will be depreciated according to a straight-line method (include the half-year
convention). The market value of the manufacturing plant and equipment
at the end of the project (t = 3) is $150,000. Variable costs are
projected at 70% of sales. There are no fixed costs associated with the
project. The project will be financed with $1,000, 3-year bonds, with a
coupon rate of 9%. Net working capital requirements are $25,000 at the
start, and then respectively 12% and 18% of sales in t = 1, and
t = 2. At t = 3 the NWC investments will be recovered.
The required rate of return on this project is 21% and the corporate tax
rate is 34%.
Calculate the NPV and IRRfor this project and indicate whether you should accept or reject the pineapple project?
(Hint: figure out for t=0,1,2,3
what the cash flows from the project are (cash flow from assets). Use the
identities we have learned in class: CF from Assets = Operating CF + additions
to NWC + Net Capital Spending. Operating CF = EBIT + Depreciation - Taxes