Best Food Company is considering a new product whose data are shown below. The e

Question

Best Food Company is considering a new product 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 change in net operating 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 Best products and would reduce their pre-tax annual cash flows. What is the project's NPV? IRR? Discuss the results.

WACC

10.0%

Pre-tax cash flow reduction for other products (cannibalization)

$5,000

Investment cost (depreciable basis)

$80,000

Annual sales revenues

$67,500

Annual operating costs (excl. depreciation)

$25,000

Tax rate

35.0%

WACC

10.0%

Pre-tax cash flow reduction for other products (cannibalization)

$5,000

Investment cost (depreciable basis)

$80,000

Annual sales revenues

$67,500

Annual operating costs (excl. depreciation)

$25,000

Tax rate

35.0%

Explanation / Answer

PART - A

Calculation of Net Present Value

Step - 1

Calculation of Cash Flow After Depreciation and Tax

Step - 2

Calculation of Net Present Value

NPV = $ 3830

Part - 2

Calculation of Internal Rate of Return

IRR = (Discounted Cash inflow = Discounted Cash Outflow)

=80000/33708.50

=2.3733 (Present Value Annuity Factor Table)

=12.70%

Internal Rate of Return = 12.70%

Particulars Amount in $ Sales 67500 Less:Operating Costs 25000 Profit 42500 Less:Cash Flow reduction for other products 5000 Cash Flow before Depreciation and Tax 37500 Less:Depreciation (80000/3) 26667 Cash Flow before Tax 10833 Less : Tax @ 35% 3791.50 Cash Flow After Tax 7041.50 Add; Depreciation 26667 Cash Flow After Tax and Depreciation 33708.50

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