CAPITAL BUDGETING AND CASH FLOW ESTIMATION Allied Food Products is considering expanding into the fruit juice business with a new fresh lemon juice product. Assume 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 purchase price of the required equipment is $$280,000,$ including shipping and installation costs, and the equipment is eligible for $100\%$ bonus depreciation at the time of purchase. In addition, inventories would rise by $$25,000,$ while accounts payable would increase by $$5,000.$ All of these costs would be incurred at t $=0.$

$$The project is expected to operate for $4$ years, at which time it will be terminated. The cash inflows are assumed to begin $1$ year after the project is undertaken, or at t $=1,$ and to continue out to t $=4.$ At the end of the project$$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\mathrm{.}00$ per unit. Cash operating costs for the project are expected to total $60\%$ of dollar sales. Allied$$s tax rate is $25\%,$ and its WACC is $10\%.$ Tentatively, the lemon juice project is assumed to be of equal risk to Allied$$s other assets.

$$You have been asked to evaluate the project and to make a recommendation as to whether it should be accepted or rejected. To guide you in your analysis, your boss gave you the following set of tasks$/$questions:

b$.$

$1.$Allied uses debt in its capital structure, so some of the money used to finance the project will be debt. Given this fact, should the projected cash flows be revised to show projected interest charges? Explain.

$2.$Suppose you learned that Allied had spent $$50,000$ to renovate the building last year, expensing these costs. Should this cost be reflected in the analysis? Explain.

$3.$Suppose you learned that Allied could lease its building to another party and earn $$25,000$ per year. Should that fact be reflected in the analysis? If so$,$ how?

$4.$Assume that the lemon juice project would take profitable sales away from Allied$$s fresh orange juice business. Should that fact be reflected in your analysis? If so$,$ how?

c$.$Disregard all the assumptions made in part b and assume there is no alternative use for the building over the next $4$ years. Now calculate the project$$s NPV$,$ IRR, MIRR, and payback. Do these indicators suggest that the project should be accepted? Explain.

d$.$If this project had been a replacement rather than an expansion project, how would the analysis have changed? Think about the changes that would have to occur in the cash flow table.

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