Case

Fruit-To-Go (FTG) processes fruit for shipping overseas.

FTG commissioned a study to look into the feasibility of changing the packaging of the fruit from cans to sealed bags. The Consultant charged $45000 for the report.

The report concluded that the new packaging will increase sales and reduce some operating costs.

The new packaging machinery will cost $1100000. The new machine is expected to last 5 years. The Taxation Office advise the life of the machine, for tax purposes, is 4 years.

The old canning machinery was purchased 2 years ago for $800000 and was being depreciated at $200000 and will be for the next 2 years. The old machine could be sold today for $130000. In 5 years it will be worth nothing.

Installing the new machine will require staff training (a tax deductible expense) of $35000 before production can commence. Due to the lower cost of the bags Inventory required will be reduced by $100000 for the life of the project.

The new sales of bagged fruit is expected to be $750000 in Year 1 rising by 20% for 1 year then 10% for the rest of the life of the project. Variable Costs associated with the new packaged fruit are 40% of sales.

Canned fruit production will be discontinued. Sales of canned fruit were static at $400000 with variable costs of $200000 (50% of Sales).

The new equipment is very hi-tech. Maintenance costs are expected to be higher at $40000 per year. Maintenance costs on the old machine were $30000 per year.

The lighter packaging will reduce annual freight cost significantly from $250000 to $140000 per year.

Fixed costs are expected to remain at $450000 per year.

At the end of the project the new machinery can be sold for $350000.

Notes:

FTG will borrow the full Year 0 funds using a secured five-year interest-only loan at an interest rate of 10% per annum to finance the new equipment.

The company tax rate is 30%.

The required rate of return is 12.5%.

Requirement:

You are required to answer and to conduct a capital budgeting analysis of the company. You must determine:

1. The cash flows at the start 15Marks

2. The cash flows over the life 20Marks

3. The cash flows at the end 10 Marks

4. The appropriate discount rate 5 Marks

5. The NPV of the project 5Marks

6. The IRR of the project5Marks

7. The PI of the project5Marks

8. The payback of the project5Marks

9. A brief recommendation 5Marks

10. Please give short explanation on how to make investing decision. (about 500 words) 25Marks