Texmex Food Company is considering a new salsa whose data are shown below. The e

Question

Texmex Food Company is considering a new salsa whose data are shown below. The equipment to be used would be depreciated by the straight line method over its 3-year life and would have a zero salvage value and no new working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life. However, this project would compete with other Texmex products and would reduce their pre-tax annual cash flows. What is the projects NPV?
(Hint: Cash flows are cosntant years 1-3)

WAAC = 10%
Pre tax cash flow reduction for other products(cannibalization) = $5,000
Investment costs(depreciable basis) = $80,000
Straight line depr rate = 33.333%
Sales revenues, each for 3 years = $67,500
Annual operating costs (excl deprec) = $25,000
Tax rate = 35.0%

Explanation / Answer

t=0 t=1 t=2 t=3 Investment (Basis) WACC = 10% $80,000 Sales revenues $67,500 $67,500 $67,500 Cannibalization cost $5,000 $5,000 $5,000 Operating costs (excl. deprec.) $25,000 $25,000 $25,000 depreciation Rate = 33.33% $26,667 $26,667 $26,667 Operating income (EBIT) $10,833 $10,833 $10,833 Taxes @ 35% $3,792 $3,792 $3,792 After-tax EBIT $7,041 $7,041 $7,041 Add depreciation $26,667 $26,667 $26,667 $33,708 $33,708 $33,708 Cash Flow -$80,000 $33,708 $33,708 $33,708 PV @ 10% -$80,000 $30,644 $27,858 $25,326 NPV $3,828

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