12 Case model - 12 Case model 3/22/2010 7:09 2/21/2006...

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12 Case model 3/22/2010 7:09 2/21/2006 Chapter 12. Cash Flow Estimation and Risk Analysis Allied Food Products is considering expanding into the fruit juice business with a new fresh lemon product. Assume that you were recently hired as assistant to the director of capital budgeting, and you must evaluate the new project. The lemon juice would be produced in an unused building adjacent to Allied’s Fort Myers plant; Allied owns the building, which is fully depreciated. The required equipment would cost $200,000, plus an additional $40,000 for shipping and installation. In addition, inventories would rise by $25,000, while accounts payable would go up by $5,000. All of these costs would be incurred at t = 0. By a special ruling, the machinery could be depreciated under the MACRS system as 3-year property. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The project is expected to operate for 4 years, at which time it will be terminated. The cash inflows are assumed to begin 1 year after the project is undertaken, or at t = 1, and to continue out to t = 4. At the end of the project’s life (t = 4), the equipment is expected to have a salvage value of $25,000. Unit sales are expected to total 100,000 units per year, and the expected sales price is $2.00 per unit. Cash operating costs for the project (total operating costs less depreciation) are expected to total 60 percent of dollar sales. Allied’s tax rate is 40%, and its WACC is 10%. Tentatively, the lemon juice project is assumed to be of equal risk to Allied’s other assets. You have been asked to evaluate the project and to make a recommendation as to whether it should be accepted or rejected. To guide you in your analysis, your boss gave you the following set of questions. INPUT DATA Initial Costs Equipment $200,000 Shipping and installation $40,000 Expected salvage value $25,000 Changes in net WC Inventories $25,000 Accounts payable $5,000 MACRS 3-year depreciation rates Year 1 2 3 4 Rate 0.33 0.45 0.15 0.07 Expected unit sales 100,000 Price per unit $2.00 Operating costs (% of sales) 60.0% Tax rate 40.0% WACC 10.0% PART A Allied has a standard form that is used in the capital budgeting process; see Table IC12-1. Part of the table has been completed, but you must replace the blanks with the missing numbers. Complete the table in the following steps: (1) Fill in the blanks under year 0 for the initial investment outlay. (2)
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This note was uploaded on 03/21/2010 for the course BUSINESS AB102 taught by Professor Woo during the Spring '10 term at Nanzan.

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12 Case model - 12 Case model 3/22/2010 7:09 2/21/2006...

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