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Instructions: Identifying Relevant Cash Flows Suppose a beverage company is considering adding a new product line. Currently the company sells apple juice and they are
Instructions:
Identifying Relevant Cash Flows | |||||||
Suppose a beverage company is considering adding a new product line. | |||||||
Currently the company sells apple juice and they are considering selling a fruit drink. | |||||||
The fruit drink will have a selling price of $1.00 per jar. The plant has excess capacity in a | |||||||
fully depreciated building to process the fruit drink. The fruit drink will be discontinued in four years. | |||||||
The new equipment is depreciated to zero using straight line depreciation. The new fruit drink requires | |||||||
an increase in working capital of $25,000 and $5,000 of this increase is offset with accounts payable. | |||||||
Projected sales are 150,000 jars of fruit drink the first year, with a 20 percent growth for the following years. | |||||||
Variable costs are 55% of total revenues and fixed costs are $10,000 each year. The new equipment costs | |||||||
$195,000 and has a salvage value of $25,000. | |||||||
Bond Information | |||||||
The corporate tax rate is 35 percent and the company currently has 1,000,000 shares of stock outstanding | |||||||
at a current price of $15. The company also has 50,000 bonds outstanding, with a current price of $985. The | |||||||
bonds pay interest semi-annually at the coupon rate is 6%. The bonds have a par value of $1,000 and will | |||||||
mature in twenty years. | |||||||
Equity Information | |||||||
Even though the company has stock outstanding it is not publicly traded. Therefore, there is no publicly | |||||||
available financial information. However, management believes that given the industry they | |||||||
are in the most reasonable comparable publicly traded company is Cott Corporation (ticker symble | |||||||
is COT). In addition, management believes the S&P 500 is a reasonable proxy for the market portfolio. | |||||||
Therefore, the cost of equity is calculated using the beta from COT and the market risk premium based on the | |||||||
S&P 500 annual expected rate of return. (The best estimate for the expected return on the market is to look at | |||||||
long run historical averages of the stock market. I provided you the historical long run average in Module 5 | |||||||
under page Historical Asset Averages. Next go to US Treasury Yield website to obtain current 3 month T-bill rate.) | |||||||
WACC is then calculated using the CAPM and beta estimate as discussed for COT since it is in the same industry. | |||||||
Clearly show all your calculations and sources for all parameter estimates used in the WACC. | |||||||
Required | |||||||
1. Calculate the WACC for the company. | |||||||
2. Create a partial income statement incremental cash flows from this project in the | |||||||
Blank Template worksheet using the tab below. | |||||||
3. Enter formulas to calculate the NPV by finding the PV of the cash flows over the next four years. | |||||||
(You can either use the EXCEL formula PV() or use mathmatical formula for PV of a lump sum.) | |||||||
4. Set up the EXCEL worksheet so that you are able to change the parameters in E3 to E12. | |||||||
Run three cases best, most likely, and worst case where the growth rate is 30%, 20%, and 5%, | |||||||
respectfully. | |||||||
5. Create a NPV profile for the most likely case scenario. (See NPV Calculation tab below.) | |||||||
6. State whether the company should accept or reject the project for each case scenario. | |||||||
7. Summarize your recommendation on a one-page pdf or doc file with the following: | |||||||
a. NPV for each case | |||||||
b. NPV profile graph for most likely case | |||||||
c. Very brief (two or three sentence at most) recommendation of accepting or rejecting project. | |||||||
d. Your brief recommendation should include a note stating which parameter estimates you are most uncertain of. | |||||||
question:
- Please NOTE: The ticker COT is no longer available. Please use MNST as the comparison company for obtaining a beta.
- Please follow the instructions on the first worksheet of the following Excel template.
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