Riverlea Swine is considering a proposal to manufacture high-protein pig feed. T

Question

Riverlea Swine is considering a proposal to manufacture high-protein pig feed. The project would make

use of an existing warehouse, which is currently rented out to a neighbouring firm. The next year's rental charge

on the warehouse is $100,000, and thereafter the rent is expected to grow in line with inflation at 4 percent a

year. In addition to using the warehouse, the proposal envisages an investment in plant and equipment of

$1.2 million.

This could be depreciated for tax purposes straight-line over 10 years. However, Riverlea Swine expects

to terminate the project at the end of eight years and to resell the plant and equipment in year 8 for $400,000.

Finally, the project requires an initial investment in working capital of $350,000.

Year 1 sales of pig feed are expected to be $4.2 million, and thereafter sales are forecast to grow by

5 percent a year, slightly faster than the inflation rate. Manufacturing costs are expected to be 90 percent of

sales, and projects are subject to tax at 30 percent. The cost of capital is 12 percent

Required

Using Excel prepare an analysis to be presented to the Chief Executive Officer of Riverlea

Swine evaluating the proposed project. Your analysis should include the following

• Table of cash flows

• Use of formulae where appropriate

Explanation / Answer

cash flows out:
rent at 100,000, because this is an opportunity cost - you arent getting the money in even though you are not actually spending it
Add 4 % each year so 100,000 year 1
104,000 year 2
108 160 year 3


purchase of equipment is 1.2m out in year 0
sale is 400,000 in year 8
ignore depreciation - not a cash flow

350,000 working capital out in year 0
increase it to be in line with sales so it becomes 420,000 in year 1 which is a cash outflow of 70,000

sales at 4,2 million a year will be an inflow increasing by 5 %
off set cost of sales of 90% so actual inflow will be 420,000 in year 1

tax is paid a year late, but for year 1 the taxable profit would be 420,000 less the 10% depreciation of 120,000
so tax paid in year 2 will be 30% of 120,000

make a table of your cash flows, get the total movement for each year then apply your 12% cost of capital to reduce it to today's value.

does this help at all?

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