Answered: a. What are the free cash flows of the…

Corporate Fin Focused Approach

5th Edition

ISBN:9781285660516

Author:EHRHARDT

Publisher:EHRHARDT

Chapter11: Cash Flow Estimation And Risk Analysis

Section: Chapter Questions

Problem 1eM

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Question

Arnold Inc. is considering a proposal to manufacture high-end protein bars used as food supplements by body builders. The project requires use of an existing warehouse, which the firm acquired three years ago for

million and which it currently rents out for

$139,000.

Rental rates are not expected to change going forward. In addition to using the warehouse, the project requires an upfront investment into machines and other equipment of

$1.3

million. This investment can be fully depreciated straight-line over the next 10 years for tax purposes. However, Arnold Inc. expects to terminate the project at the end of eight years and to sell the machines and equipment for

$422,000.

Finally, the project requires an initial investment into net working capital equal to 10 percent of predicted first-year sales. Subsequently, net working capital is 10 percent of the predicted sales over the following year. Sales of protein bars are expected to be

$4.9

million in the first year and to stay constant for eight years. Total manufacturing costs and operating expenses (excluding depreciation) are 80 percent of sales, and profits are taxed at 30 percent.

a. What are the free cash flows of the project? (starting with year 0)

b. If the cost of capital is

15%,

what is the NPV of the project?

list all answers to the third decimal point

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