Over Lunch You And Mary Meet To Discuss Next Steps 951013

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. “It must be time to compute the net present value (NPV) and internal rate of return (IRR) of the Apix expansion project,” Mary responds. “We have the data from James and Luke regarding projected sales and costs, respectively, for the food packaging project. 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.” You agree, “That sounds good.” Mary confirms, “You can use a WACC of 10% for the computation of the NPV and comparison for IRR.” You respond, “I’ve got the information I need from Luke and James.” You then hand a sheet of paper to Mary, saying, “Does this look right to you? Let’s look at this now while we’re together.” Mary reviews the provided data and says, “It looks good. Use this information from Luke and James to compute the cash flows for the project.” You confirm, “No problem.” Mary then instructs, “Then, compute NPV and IRR of the project using the Excel spreadsheet I sent earlier today. Use the IRR financial function for the computation of IRR.” You conclude, “Okay. I’ll submit my Excel file showing the calculation of cash flows, NPV, and IRR by the end of the week so you can review it over the weekend.” Mary responds, “Thanks.”

Paper For Above instruction

The decision to undertake the expansion project involves comprehensive financial analysis to evaluate its viability and profitability. Key metrics in this analysis include the Net Present Value (NPV) and Internal Rate of Return (IRR), which are used to assess whether the project will generate value exceeding its costs and to determine the potential rate of return, respectively.

The initial investment outlay for the project is specified at $30 million, comprising $25 million allocated for equipment and $5 million for net working capital (NWC), including inventory of plastic substrate and ink. NWC is expected to be recoverable at the end of the project’s five-year lifespan. The project’s projected cash inflows consist of annual sales of $25 million, with a gross margin of 60% before considering depreciation and operating expenses.

Depreciation expenses are calculated using the straight-line method over five years, consistent with the tax treatment outlined by the audit firm. This method evenly distributes the depreciation expense across each year of the equipment’s useful life, effectively reducing taxable income accordingly. When calculating taxes, the corporate tax rate is assumed to be 35%, a reduction from previous rates based on recent fiscal policies. Selling, general, and administrative (SG&A) expenses are projected at 10% of sales, impacting net profitability.

The project’s valuation analysis assumes a weighted average cost of capital (WACC) of 10%, which serves as the discount rate for NPV calculations. This rate reflects the opportunity cost of capital and risk premiums associated with the project, incorporating the firm’s cost of debt and equity. Tax benefits from depreciation and potential tax breaks are incorporated into the cash flows, enhancing the project’s attractiveness.

To compute the project's cash flows, initial investments are recorded as outflows in Year 0, with subsequent inflows derived from operating cash flows, tax savings from depreciation, and the recovery of NWC at the end of Year 5. Operating cash flow calculations involve adjusting earnings for non-cash depreciation expenses and taxes, which are calculated on earnings before depreciation. The cash flows are then discounted at the WACC of 10% to determine the NPV.

The IRR is calculated as the discount rate that sets the NPV of all cash flows to zero, generally computed using Excel’s IRR function. This metric reflects the project's expected rate of return and is compared against the WACC to determine viability—an IRR exceeding the WACC indicates a potentially worthwhile investment.

The analysis shows that, based on the projected cash flows, depreciation schedules, tax implications, and discount rate, the project’s NPV and IRR will inform the strategic decision. If the NPV is positive and the IRR exceeds the WACC, the project is deemed financially feasible and likely to add value to the firm.

References

• Damodaran, A. (2010). Damodaran on Valuation: Security Analysis for Investment and Corporate Finance. John Wiley & Sons.
• Ross, S. A., Westerfield, R. W., & Jaffe, J. (2019). Corporate Finance (12th ed.). McGraw-Hill Education.
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