Capital Budgeting Project

Standard Food Company plans to establish a new production line for producing ice creams. The

equipment costs $$300,000$ with a $10-$year life. For depreciation the company is using MACRS

method $($you need to check the IRS table online or in the textbook$).$ The project is expected to

generate $$200,000$ worth of sale every year. The annual fixed expense is $$40,000$ per year, and

the variable cost is always $35\%$ of the revenue of the same year. Starting at year $0,$ the company

needs to maintain an inventory that is worth $15\%$ of next year's sale. At the end of the project, no

inventory needs to be maintained and all existing inventory will be liquidated. Also, at the end of

the project the equipment will be sold at a market value of $$20,000.$ Assuming the tax rate is $25\%$

and the cost of capital is $9\%$ for the company.

a$.$ Create a capital budgeting table with the calculation of Free Cash Flows for each year of the

project. $(17$ points, you must show all your work to earn full credits$)$

b$.$ Calculate the Project's NPV$,$ IRR, Regular Payback Period, Discounted Payback Period and

Modified Internal Rate of Return, assuming a $9\%$ reinvestment rate $(10$ points$)$ Please show all

your work for full credit.

c$.$ From part b$,$ the company faces two different scenarios: one scenario is the scenario in part a and

b when sales are given as $200,000$; in another scenario the sales are $175,000.$ The probability of

each scenario is listed below:

Please solve the NPV for the different scenario $(3$ points, if you did everything correctly in Excel,

the NPV result would show up when you change the sales$),$ and the expected NPV and standard

deviation of NPV based on all scenarios. $(4$ points$)$

d$.$ From part b$,$ please calculate the sensitivity of NPV to sales $(3$ points$)$ and the sensitivity of NPV

to the cost of equipment at year $0(3$ points$).($Hint: you can put a $10\%$ increase for each variable

and calculate the corresponding NPV$).$ Which variable would affect NPV more effectively? $(2$

points$)$