Exotic Food Inc., a food processing company located in Herndon, VA$,$ is considering adding a new division to produce fresh ginger juice. Following the ongoing TV buzz about significant health benefits derived from ginger consumption, the managers believe this drink will be a hit. However, the CEO questions the venture's profitability, given the high costs involved. To address his concerns, you have been asked to evaluate the project using three capital budgeting techniques $($i$.$e$.,$ NPV$,$ IRR, and Payback$)$ and present your findings in a report.

CASE OVERVIEW

The main equipment required is a commercial food processor, which costs $$200,000.$ The shipping and installation cost of the processor from China is $$50,000.$ The processor will be depreciated under the MACRS system using the applicable depreciation rates are $33\%,45\%,15\%,$ and $7\%,$ respectively. Production is estimated to last for three years, and the company will exit the market before intense competition sets in and erodes profits. The market value of the processor is expected to be $$100,000$ after three years. Net working capital of $$2,000$ is required at the start, which will be recovered at the end of the project. The juice will be packaged in $20$ oz$.$ containers that sell for $$3\mathrm{.}00$ each. The company expects to sell $150,000$ units per year; the cost of goods sold is expected to total $70\%$ of dollar sales.

Weighted Average Cost of Capital $($WACC$)$:

Exotic Food's common stock is currently listed at $$75$ per share; new preferred stock sells for $$80$ per share and pays a dividend of $$5\mathrm{.}00.$ Last year, the company paid dividends of $$2\mathrm{.}00$ per share for common stock, which is expected to grow at a constant rate of $10\%.$ The local bank is willing to finance the project at $10\mathrm{.}5\%$ annual interest. The company's marginal tax rate is $35\%,$ and the optimum target capital structure is:

Exotic Food Capital Structure

Cost of Capital Percentage

Common equity $50\%$

Preferred $20\%$

Debt $30\%$

Your main task is to compute and evaluate the cash flows using capital budgeting techniques, analyze the results, and present your recommendations on whether the company should take on the project.

QUESTIONS

To help in the analysis, answer all the following questions. Present the analysis in one Excel file with the data, computations, formulas, and solutions. It is preferred that the Excel file be embedded inside the WORD document $($question $8).$

What is the total investment amount at the start of the project $($i$.$e$.,$ year zero cash flow$)?$

What is the depreciation amount for each year?

Create a depreciation schedule

What is the after$-$tax salvage value of the equipment?

What are the projected net income and Operating Cash Flows $($OCF$)$ for the three years?

Complete an income statement for each year.

What are the Free Cash Flows $($FCF$)$ generated from the project?

Create a projected cash flow schedule

What is the Weighted Average Cost of Capital $($WACC$)?$

Compute the after$-$tax cost of debt

Compute the cost of common equity

Compute the cost of preferred stock

Compute the Weighted Average Cost of Capital $($WACC$)$

Using a WACC of $15\%,$ apply four capital budgeting techniques to evaluate the project, assuming the Free Cash Flows are as follows:

Cash Flows

Years Free Cash Flows

$0($$$252,000\mathrm{.}00)$

$1$ $$118,625\mathrm{.}00$

$2$ $$127,125\mathrm{.}00$

$3$ $$181,000\mathrm{.}00$

The four techniques are NPV$,$ IRR, MIRR, and discounted Payback. Assume the reinvestment rate to be $8\%$ for the MIRR. Also, assume that the business will only accept projects with a payback period of two and a half years or less.

Which of the four techniques should be selected and why?