Question
Eagles Brewing Company is considering a proposal to install a new bottling system.In reviewing the proposal, the company's CFO is considering the following facts: The
Eagles Brewing Company is considering a proposal to install a new bottling system.In reviewing the proposal, the company's CFO is considering the following facts: The bottling system will cost $3,000,000 today.These costs will be depreciated at a 4-yr straight line for tax and accounting purposes, starting from year 1. At the end of three years, the company will get out of the bottling business and sell the used equipment for $200,000. The equipment will be housed in the firm's existing building (built ten years ago), currently empty.The building originally cost $5,000,000.If it is not used for the project, the building can be sold for $500,000 (This is its after-tax value). If it is used for the project, it will have no value at the end of 3 years. A major factor in the decision to go ahead with the project was its testing program results.Two years ago, the company spent $150,000 on its test program for this project. The project will require a $400,000 increase in inventory and a $100,000 increase in accounts payable, both occurring today. All working capital will be recovered in the last (terminal) year of the project and is not affected by inflation. The new business is expected to generate $9 million in sales in year 1.The operating costs, excluding depreciation, will be $7 million in year 1. Revenues and operating costs will increase at the inflation rate of 2% starting in year 2. The opportunity cost of capital is 12%, and the firm has a tax rate of 20%.
A. What are the after-tax operating profit (NOPAT) for this project from year 1 to year 3.
B. What are the incremental free cash flows for this project from year 0 to year 3.
C. What is the NPV and IRR of this project?Should Eagle Brewing take the project?
D. How sensitive is the decision in (c) to the revenue assumption in year 1?
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