12 Case model
Cash Flow Estimation and Risk Analysis
Allied Food Products is considering expanding into the fruit juice business with a new fresh lemon product.
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
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
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
To guide you in your analysis, your boss gave you the following set of questions.
Shipping and installation
Expected salvage value
Changes in net WC
MACRS 3-year depreciation rates
Expected unit sales
Price per unit
Operating costs (% of sales)
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:
Fill in the blanks under year 0 for the initial investment outlay.