Expansion Project Scenario PopFizz Soda Company The PopFizz Soda Company has decided to capitalize on the flavored water fad and plans to open a new factory. To get the project underway, the company will rent space adjacent to its current factory. The equipment required for the new factory will cost $600,000. Shipping and installation charges for the equipment are expected to total $50,000. This equipment will be depreciated on a straight-line basis over its five-year economic life to an estimated salvage value of $0. In order to begin production of the flavored water, PopFizz Soda estimates that it will have to add about $80,000 initially to its net working capital in the form of additional inventories of plastic bottles, sugar, water, and packaging (less accounts payable to suppliers). During the first year of operations, PopFizz Soda expects its total revenues (from flavored water) to increase by $600,000 above the level that would have prevailed from just soda sales. These incremental revenues are expected to grow to $700,000 in year 2, $850,000 in year 3, decline to $700,000 in year 4, and decline again to $450,000 during the fifth and final year of the projects life. The companys incremental operating costs associated with the new plant, including the rent of the space, are expected to total $250,000 during the first year and increase at a rate of 5 percent per year over the five-year project life. Depreciation will be $130,000 per year ($650,000 installed cost, assuming no salvage value, divided by five-year economic life). PopFizz Soda has a marginal tax rate of 25 percent. In addition, PopFizz Soda expects that it will have to add about $65,000 per year to its net working capital in years 1, 2, and 3 and nothing in years 4 and 5. At the end of the project, the total accumulated net working capital required by the project will be recovered.

Expansion Project Scenario PopFizz Soda Company The PopFizz Soda Company has decided to capitalize on the flavored water fad and plans to open a new factory. To get the project underway, the company will rent space adjacent to its current factory. The equipment required for the new factory will cost $600,000. Shipping and installation charges for the equipment are expected to total $50,000. This equipment will be depreciated on a straight-line basis over its five-year economic life to an estimated salvage value of $0. In order to begin production of the flavored water, PopFizz Soda estimates that it will have to add about $80,000 initially to its net working capital in the form of additional inventories of plastic bottles, sugar, water, and packaging (less accounts payable to suppliers). During the first year of operations, PopFizz Soda expects its total revenues (from flavored water) to increase by $600,000 above the level that would have prevailed from just soda sales. These incremental revenues are expected to grow to $700,000 in year 2, $850,000 in year 3, decline to $700,000 in year 4, and decline again to $450,000 during the fifth and final year of the projects life. The companys incremental operating costs associated with the new plant, including the rent of the space, are expected to total $250,000 during the first year and increase at a rate of 5 percent per year over the five-year project life. Depreciation will be $130,000 per year ($650,000 installed cost, assuming no salvage value, divided by five-year economic life). PopFizz Soda has a marginal tax rate of 25 percent. In addition, PopFizz Soda expects that it will have to add about $65,000 per year to its net working capital in years 1, 2, and 3 and nothing in years 4 and 5. At the end of the project, the total accumulated net working capital required by the project will be recovered.

Expansion Project Scenario PopFizz Soda Company The PopFizz Soda Company has decided to capitalize on the flavored water fad and plans to open a new factory. To get the project underway, the company will rent space adjacent to its current factory. The equipment required for the new factory will cost $600,000. Shipping and installation charges for the equipment are expected to total $50,000. This equipment will be depreciated on a straight-line basis over its five-year economic life to an estimated salvage value of $0. In order to begin production of the flavored water, PopFizz Soda estimates that it will have to add about $80,000 initially to its net working capital in the form of additional inventories of plastic bottles, sugar, water, and packaging (less accounts payable to suppliers). During the first year of operations, PopFizz Soda expects its total revenues (from flavored water) to increase by $600,000 above the level that would have prevailed from just soda sales. These incremental revenues are expected to grow to $700,000 in year 2, $850,000 in year 3, decline to $700,000 in year 4, and decline again to $450,000 during the fifth and final year of the projects life. The companys incremental operating costs associated with the new plant, including the rent of the space, are expected to total $250,000 during the first year and increase at a rate of 5 percent per year over the five-year project life. Depreciation will be $130,000 per year ($650,000 installed cost, assuming no salvage value, divided by five-year economic life). PopFizz Soda has a marginal tax rate of 25 percent. In addition, PopFizz Soda expects that it will have to add about $65,000 per year to its net working capital in years 1, 2, and 3 and nothing in years 4 and 5. At the end of the project, the total accumulated net working capital required by the project will be recovered.

Identify two assumptions that are used in the scenario to generate the annual cash flows.

Explain how each of these two assumptions could be incorrect and how that error could impact the net present value of the project and the capital budgeting decision.

Propose one method to strengthen the process of estimating annual cash flows for capital budgeting decisions.