Data In order to produce the new product, Vitasoy will acquire new equipment at

Question

Data In order to produce the new product, Vitasoy will acquire new equipment at a cost of $5 million It will depreciate this capital expenditure over the 5 years of this project on a straight line basis This means the project will have an annual depreciation expense of $5M Annual Depreciation =-= -$1M The new energy drink is expected to be marketed for 5 years. Over those 5 years, Vitasoy projects the following sales figures End of Year Units Sold (in 000s) 5000 7000 10000 8000 4000 Av. Price Per Unit 1.60$1.60 $1.75 $1.75 $1.75 Sale (in $000s) $8,000 $11,200 $17,500 $14,000 $7,000 In terms of costs, Vitasoy projects the following: Gross Profit Margin: 25%. This means that it expects the cost of producing each can (COGS) to be 75% of the sale price. ·Operating Expenses: 6% of sales (listed as selling, general, and administrative) Corporate Tax Rate: 40% . Opportunity Cost of Capital: 10% In terms of Net Working Capital, Vitasoy projects the following: . Cash: 2% of sales . Inventory: 3% of sales . Receivables: 15% of sales Payables: 15% of cost of COGS » Year 5: Assume all four items go back to zero

Explanation / Answer

NPV of the Project under 1st Alternative without salvage value Capital Expenditures and Depreciation Cost of New Equipment (In $000's) $5,000 Depreciation (in years) 5 Annual Depreciation $1,000 Costs Gross Profit Margin 25% SG&A 6% Tax Rate 40% Opportunity cost of capital 10% Sales Projections End of Year 0 1 2 3 4 5 Units Sold (In 000's) 5000 7000 10000 8000 4000 Avg Price Per unit $1.60 $1.60 $1.75 $1.75 $1.75 Sales (in 000's) $8,000.00 $11,200.00 $17,500.00 $14,000.00 $7,000.00 Net Working Capital Assumptions Cash 2% of Sales Inventory 3% of Sales Receivables 15% of Sales Payables 15% of COGS Net Working Capital Projections End of Year 0 1 2 3 4 5 Cash $160.00 $224.00 $350.00 $280.00 $140.00 $0.00 Inventory $240.00 $336.00 $525.00 $420.00 $210.00 $0.00 Receivables $1,200.00 $1,680.00 $2,625.00 $2,100.00 $1,050.00 $0.00 Payables $900.00 $1,260.00 $1,968.75 $1,575.00 $787.50 $0.00 Net Working Capital $700.00 $980.00 $1,531.25 $1,225.00 $612.50 $0.00 Increase in NWC ($700) ($280.00) ($551.25) $306.25 $612.50 $612.50 Cash flow Pro Forma End of Year 0 1 2 3 4 5 Sales (In 000's) $8,000.00 $11,200.00 $17,500.00 $14,000.00 $7,000.00 Cost of Goods Sold $6,000.00 $8,400.00 $13,125.00 $10,500.00 $5,250.00 Gross Profit $2,000.00 $2,800.00 $4,375.00 $3,500.00 $1,750.00 SG&A $480.00 $672.00 $1,050.00 $840.00 $420.00 Depreciation $1,000 $1,000 $1,000 $1,000 $1,000 EBIT $520.00 $1,128.00 $2,325.00 $1,660.00 $330.00 Taxes $208.00 $451.20 $930.00 $664.00 $132.00 Unlevered Net Income $312.00 $676.80 $1,395.00 $996.00 $198.00 Depreciation $1,000 $1,000 $1,000 $1,000 $1,000 Capital Expenditures ($5,000) Increase in NWC ($700) ($280) ($551) $306 $613 $613 Free Cash flow ($5,700) $1,032 $1,126 $2,701 $2,609 $1,811 Discount Factor @ 10% 1 0.9090909 0.82644628 0.7513148 0.683013455 0.62092132 PV (FCF) ($5,700) $938 $930 $2,029 $1,782 $1,124 NPV $1,103.70 NPV of the Project under 2nd Alternative without salvage value Net Working Capital Projections End of Year 0 1 2 3 4 5 Cash 160 224 350 280 140 0 Inventory 240 336 525 420 210 0 Receivables 1200 1680 2625 2100 1050 0 Payables 960 1344 1837.5 1470 735 0 Net Working Capital 640 896 1662.5 1330 665 0 Increase in NWC -640 -256 -766.5 332.5 665 665 Cash flow Pro Forma End of Year 0 1 2 3 4 5 Sales (In 000's) 8000.00 11200.00 17500.00 14000.00 7000.00 Cost of Goods Sold 6400.00 8960.00 12250.00 9800.00 4900.00 Gross Profit 1600.00 2240.00 5250.00 4200.00 2100.00 SG&A 480.00 672.00 1050.00 840.00 420.00 Depreciation 1000.00 1000.00 1000.00 1000.00 1000.00 EBIT 120.00 568.00 3200.00 2360.00 680.00 Taxes 48.00 227.20 1280.00 944.00 272.00 Unlevered Net Income 72.00 340.80 1920.00 1416.00 408.00 Depreciation 1000.00 1000.00 1000.00 1000.00 1000.00 Capital Expenditures -5000.00 Increase in NWC -640.00 -256.00 -766.50 332.50 665.00 665.00 Free Cash flow -5640.00 816.00 574.30 3252.50 3081.00 2073.00 Discount Factor @ 10% 1.0000 0.9091 0.8264 0.7513 0.6830 0.6209 PV (FCF) -5640.00 741.82 474.63 2443.65 2104.36 1287.17 NPV 1411.63 Vitasoy should use second alternative to produce its new energy drink because it has higher NPV as compared to First Alternative Capital Expenditures and Depreciation Cost of New Equipment (In $000's) $5,000 Depreciation (in years) 8 Salvage Value (In $000's) 2200 Annual Depreciation $350 Cash flow Pro Forma End of Year 0 1 2 3 4 5 Sales (In 000's) 8000 11200 17500 14000 7000 Cost of Goods Sold 6000 8400 13125 10500 5250 Gross Profit 2000 2800 4375 3500 1750 SG&A 480 672 1050 840 420 Depreciation $350 $350 $350 $350 $350 EBIT $1,170 $1,778 $2,975 $2,310 $980 Taxes $468 $711 $1,190 $924 $392 Unlevered Net Income $702 $1,067 $1,785 $1,386 $588 Depreciation $350 $350 $350 $350 $350 Capital Expenditures -5000 Increase in NWC -700 -280 -551.25 306.25 612.5 612.5 Salvage Value Depreciation for 5 yrs Book Value Gain on Sale Salvage Value 1360 2200 1400 3600 1400 Free Cash flow -5700 772 865.55 2441.25 2348.5 2910.5 Tax on Gain 560 Discount Factor @ 10% 1 0.9090909 0.82644628 0.7513148 0.683013455 0.62092132 840 PV (FCF) -5700 701.81818 715.330579 1834.14726 1604.0571 1807.19151 Cash flow - 2200-840 NPV 962.54 NPV of the Project under 2nd Alternative with salvage value Cash flow Pro Forma End of Year 0 1 2 3 4 5 Sales (In 000's) 8000 11200 17500 14000 7000 Cost of Goods Sold 6400 8960 12250 9800 4900 Gross Profit 1600 2240 5250 4200 2100 SG&A 480 672 1050 840 420 Depreciation $350 $350 $350 $350 $350 EBIT $770 $1,218 $3,850 $3,010 $1,330 Taxes $308 $487 $1,540 $1,204 $532 Unlevered Net Income $462 $731 $2,310 $1,806 $798 Depreciation $350 $350 $350 $350 $350 Capital Expenditures -5000 Increase in NWC -640 -256 -766.5 332.5 665 665 Salvage Value $1,360 Free Cash flow -5640 556 314.3 2992.5 2821 3173 Discount Factor @ 10% 1 0.9090909 0.82644628 0.7513148 0.683013455 0.62092132 PV (FCF) -5640.00 505.45 259.75 2248.31 1926.78 1970.18 NPV 1270.48 NPV of 2nd alternative is higher, hence this should be undertaken

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