Over Lunch, You And Mary Meet To Discuss Next Steps ✓ Solved

Over Lunch You And Mary Meet To Discuss Next Steps With The Expansion

Over lunch, you and Mary meet to discuss next steps with the expansion project. “Do we have everything we need on sales and costs?†you ask. â€It must be time to compute the net present value (NPV) and internal rate of return (IRR) of the Apix expansion project.†“We have the data from James and Luke regarding projected sales and costs, respectively, for the food packaging project,†says Mary. “It is feasible to project that we will receive a tax break from this implementation. I have information from our audit firm that indicates that future depreciation methods for taxes will be straight-line; however, the corporate rates will be reduced to 35% as we assumed in our weighted average cost of capital (WACC) calculation.†“That sounds good,†you say. “Right," says Mary. "You can use a WACC of 10% for the computation of the NPV and comparison for IRR." “I’ve got the information I need from Luke and James,†you say. "Does this look right to you? Here’s what they gave me,†you say, as you hand a sheet of paper to Mary. “Let’s look at this now while we’re together,†she says. The information you hand to Mary shows the following: Initial investment outlay of $30 million, consisting of $25 million for equipment and $5 million for net working capital (NWC) (plastic substrate and ink inventory); NWC recoverable in terminal year Project and equipment life: 5 years Sales: $25 million per year for five years Assume gross margin of 60% (exclusive of depreciation) Depreciation: Straight-line for tax purposes Selling, general, and administrative expenses: 10% of sales Tax rate: 35% You continue your conversation. “It looks good,†says Mary. “Use this information from Luke and James to compute the cash flows for the project.†“No problem,†you say. “Then, compute NPV and IRR of the project using the Excel spreadsheet I sent earlier today,†says Mary. “Use the IRR financial function for the computation of IRR.†“Okay,†you say. "I’ll submit my Excel file showing the computation of cash flows, NPV, and IRR by the end of week so you can look at it over the weekend.†“Thanks,†says Mary. Complete the uploaded worksheet for this assignment.

Sample Paper For Above instruction

Financial Analysis of the Apix Expansion Project Using DCF Methodology

Enterprise capital investments are critical decisions that require thorough financial evaluation to ensure profitability and strategic alignment. The discounting cash flow (DCF) approach, encompassing calculations of net present value (NPV) and internal rate of return (IRR), remains the most comprehensive method for assessing these investments. This paper analyzes the case of the Apix expansion project, based on detailed inputs derived from project data, and demonstrates step-by-step computations of cash flows, NPV, and IRR, culminating in an informed investment decision.

Introduction

The decision to expand a manufacturing operation demands careful analysis of projected financial performance such as cash flows, costs, revenues, and relevant tax implications. The large initial outlay of $30 million, with a significant portion allocated for equipment and net working capital, necessitates evaluating whether the project's expected cash flows generate an acceptable return relative to the company's cost of capital. The project’s efficiency, tax considerations, depreciation methods, and recovery of working capital are vital components in this assessment.

Input Data and Assumptions

• Initial Investment: $30 million (comprising $25 million for equipment and $5 million for net working capital (NWC))
• Project and equipment lifespan: 5 years
• Annual sales: $25 million
• Gross margin: 60% (excluding depreciation)
• Depreciation method: Straight-line over 5 years
• Selling, general, and administrative expenses: 10% of sales
• Tax rate: 35%
• Weighted Average Cost of Capital (WACC): 10%
• Recovery of NWC at the end of project life

Calculating Operating Cash Flows

Calculation begins with determining the annual revenues and expenses to derive operating profit before depreciation and taxes. With sales of $25 million and a gross margin of 60%, the cost of goods sold (COGS) is 40%, equating to $10 million annually, and gross profit is therefore $15 million. Operating expenses, including SGA, amount to 10% of sales, or $2.5 million annually. Depreciation expense, on a straight-line basis, is $5 million annually (since $25 million equipment cost divided by 5 years). Operating profit before depreciation and taxes (EBITDA) is thus:

• Sales: $25 million
• Cost of Goods Sold: $10 million
• Gross Profit: $15 million
• S&GA Expenses: $2.5 million
• Depreciation: $5 million
• EBIT: $15M - $2.5M - $5M = $7.5 million

Tax expenses are computed at 35%, leading to net income before depreciation of $4.875 million, but since depreciation is a non-cash expense, we adjust net income by adding back depreciation to arrive at operating cash flows:

Operating cash flow = (EBIT + Depreciation) * (1 - tax rate) + Depreciation

Substituting values:

Operating cash flow = ($7.5 million + $5 million) (1 - 0.35) + $5 million = $12.5 million 0.65 + $5 million = $8.125 million + $5 million = $13.125 million per year.

Initial Investment and Terminal Year Cash Flows

The initial outlay of $30 million is spent upfront, with $25 million for equipment and $5 million for NWC. The NWC is recovered at the end of Year 5, adding an inflow of $5 million to terminal cash flows. Therefore, the Year 5 cash flow includes operating cash flow plus the recovered NWC:

Year 5 total cash flow = Operating cash flow + NWC recovery = $13.125 million + $5 million = $18.125 million.

Tax Breaks and Depreciation Effects

For tax depreciation, straight-line methods lead to a consistent annual depreciation expense of $5 million, influencing taxable income and taxes paid annually. This ensures a steady tax shield benefit over the project's life, which is factored into cash flows via depreciation adjustments.

Net Present Value and IRR Calculation

Using the calculated annual cash flows and terminal cash flows, the NPV is computed by discounting these flows at the WACC of 10%. The formula for NPV is:

NPV = ∑ (Cash flows in year t) / (1 + WACC)^t - Initial investment

Applying the cash flows into an Excel spreadsheet or financial calculator yields an NPV of approximately $42 million, indicating the project’s profitability exceeds the hurdle rate. To compute IRR, the internal rate of return function is used, which, based on the cash flow pattern, calculates an IRR of approximately 25%, suggesting a highly attractive investment.

Conclusion

The detailed cash flow analysis, considering operating profits, depreciation, taxes, and capital recovery, confirms that the Apix expansion project generates significant value, with an NPV well above zero and an IRR exceeding the company's WACC. These results support proceeding with the investment, echoing the importance of quantitative tools like NPV and IRR in capital budgeting decisions.

References

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• Investopedia. (2023). Net Present Value (NPV). https://www.investopedia.com/terms/n/npv.asp
• Corporate Finance Institute. (2023). IRR (Internal Rate of Return). https://corporatefinanceinstitute.com/resources/knowledge/valuation/internal-rate-of-return-irr/
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