question archive Maize Cookie Factory wants to expand its operations into a new line of cookies
Maize Cookie Factory wants to expand its operations into a new line of cookies
Subject:FinancePrice:2.84 Bought7
Maize Cookie Factory wants to expand its operations into a new line of cookies. The company expects to sell $250,000 of the new product in the first year and $400,000 each year thereafter. The direct costs, which include labor and materials, will be 55% of sales. Indirect incremental costs will be estimated at $25,000 a year. With this project they will need new ovens that will cost a total of $350,000 and be depreciated straight line over five years. The marginal tax rate is 35% and the cost of capital is 10%. Assume revenue is collected right away and inventory is bought and paid for daily so there is no additional working capital.
1)Show the incremental cash flows for this project over an eight year period.
2)Calculate the payback period, NPV, and PI.
3)Recommend either to accept or reject this plan. Why or why not?
4)If the space to be used could otherwise be rented out for $25,000 a year how would you put that fact into the calculation? Would the project be acceptable in that case? Why or why not?
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Please find the answer in the explanation.
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Step-by-step explanation
| 1) | ||||||||||
| Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | |
| Purchase of new oven | -3,50,000 | |||||||||
| Sales revenue | 2,50,000 | 4,00,000 | 4,00,000 | 4,00,000 | 4,00,000 | 4,00,000 | 4,00,000 | 4,00,000 | ||
| Less: Cost of goods sold | 1,37,500 | 2,20,000 | 2,20,000 | 2,20,000 | 2,20,000 | 2,20,000 | 2,20,000 | 2,20,000 | ||
| Gross profit | 1,12,500 | 1,80,000 | 1,80,000 | 1,80,000 | 1,80,000 | 1,80,000 | 1,80,000 | 1,80,000 | ||
| Less: Incremental costs | 25,000 | 25,000 | 25,000 | 25,000 | 25,000 | 25,000 | 25,000 | 25,000 | ||
| Less: Depreciation (350,000 /5) | 70,000 | 70,000 | 70,000 | 70,000 | 70,000 | |||||
| Income before tax | 17,500 | 85,000 | 85,000 | 85,000 | 85,000 | 1,55,000 | 1,55,000 | 1,55,000 | ||
| Less: Taxes@35% | 6,125 | 29,750 | 29,750 | 29,750 | 29,750 | 54,250 | 54,250 | 54,250 | ||
| Income after tax | 11,375 | 55,250 | 55,250 | 55,250 | 55,250 | 1,00,750 | 1,00,750 | 1,00,750 | ||
| Add: Depreciation | 70,000 | 70,000 | 70,000 | 70,000 | 70,000 | |||||
| Incremental cash flows | -3,50,000 | 81,375 | 1,25,250 | 1,25,250 | 1,25,250 | 1,25,250 | 1,00,750 | 1,00,750 | 1,00,750 | |
| Cumulative cash flows | -3,50,000 | -2,68,625 | -1,43,375 | -18,125 | 1,07,125 | 2,32,375 | 3,33,125 | 4,33,875 | 5,34,625 | |
| 2) | ||||||||||
| Payback period | Last period number with a negative cumulative cash flow + (Absolute value / Total cash inflow during the period) | |||||||||
| 3 + (-18,125 /125,250) | ||||||||||
| 3 + 0.145 = 3.145 | years | |||||||||
| NPV | $ 2,40,481.73 | [NPV(10%,C12:J12) +B12] | ||||||||
| PI | 1.6871 | [NPV(10%,C12:J12) / B12] | ||||||||
| 3) | ||||||||||
| Project should be accepted as NPV is positive and PI is more than one. | ||||||||||
| 4) If the space to be used then rent of $25,000 should be generated | ||||||||||
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | ||
| Rent revenue | 25,000 | 25,000 | 25,000 | 25,000 | 25,000 | 25,000 | 25,000 | 25,000 | ||
| NPV | $ 1,33,373.15 | [NPV(10%,B29:I29)] | ||||||||
| Project should be acceptable as NPV is lower, when the project is not accepted. So, the project is acceptable. | ||||||||||
