Eat Your Veggies! is a new player in the market for vegan products. Due to its initial success the company is considering a new four-year expansion project that requires an initial investment in fixed assets of 1,67 million. These assets will be depreciated using the straight-line method to a book value of zero over their four-year useful life. At the end of the project, the assets are expected to have a market value of 435.000 and it is assumed that they will be sold for this amount (hint: do not use this as a residual value in calculating annual depreciation expense). In addition, the project involves an investment in working capital (t = 1), with inventory expected to increase by 148.000, accounts receivable by 128.000, and accounts payable by 78.000. These levels will remain constant during the expansion project and will be recovered at the end of the project (i.e. working capital drops to zero at t = 4). It is estimated that the project will generate 1.850.000 in sales each year and 1.038.000 in annual costs of goods sold. The applicable income tax rate is 21% and the required rate of return for the project is 16,4% per year.

a) For each of the four years of the project, prepare a forecast of the projects

i. Unlevered net income

ii. Free cash flows

Hint: Unlevered net income is 311.655 in year 1.

Hint: Free cash flow is 531.155 in year 1.

b) Determine the projects net present value. Based on your results, should the company proceed with the expansion project? Hint: NPV should be somewhere between 470.000 and 480.000.

c) Do you think the projects IRR is greater or less than the required rate of return of 16.4%? Briefly explain your reasoning.

d) What is the amount of the depreciation tax shield? How do you interpret it?

e) Assume now that in addition to the costs mentioned earlier, the firm has also completed a technical evaluation of its product expansion project costing $1 million. Would this change the NPV for the decision to expand production? If so, by how much? If not, why not?