TexMex Food Company is considering a new salsa whose data are shown below. The e
ID: 2756933 • Letter: T
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 project's NPV? (Hint: Cash flows are constant in Years 1-3.)
10.0%
-$5,000
$80,000
33.333%
$64,000
-$25,000
35.0%
-$1,830
-$1,921
-$2,287
-$2,123
-$2,050
WACC10.0%
Pre-tax cash flow reduction for other products (cannibalization)-$5,000
Investment cost (depreciable basis)$80,000
Straight-line depr. rate33.333%
Sales revenues, each year for 3 years$64,000
Annual operating costs (excl. depr.)-$25,000
Tax rate35.0%
Explanation / Answer
CALCULATION OF NET PRESENT VALUE
Out flow at the begining of the year = $80000
Annual Cash Flows :
Sales each year = $64000
Reduction in annual sales due to competition = -$5000
Annual Operating Cost = -$25000
Annual Depreciation expense = -$26666
Pre tax Operating income = $7334
Tax @35% = -$2567
After tax operating income = $4767
Add: Depreciation expense(Since it is not
actual cash outflow = $26666
Annual Cash inflows = $31433
Net Present value = -Outflow+Annual cash inflows *[PVIFA(10%,3years)
= - $80000 +($31433*2.4868)
= -$80000+$78170
= -$1830
Answer (a)
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