Question
Little Ceasers produces 10 million frozen pizzas each year and recently the company signed a 10-year sales contract to supply a grocery chain with frozen
Little Ceasers produces 10 million frozen pizzas each year and recently the company signed a 10-year sales contract to supply a grocery chain with frozen pizzas. As a result of the contract, Little Ceasers will add 1 million units to sales in the current year, and the sales will grow at 20% in the following four years, after that, the sales will remain constant for the rest of the contract. TB sold frozen pizzas for $1.7 in last year and the price is expected to increase at the rate of inflation, which is 2%.
To increase production capacity, Little Ceasers is considering an expansion proposal, which requires four main expenditures at the beginning:
Expanding the existing building will cost $1 million;
Adding a freezer will cost $1.5 million;
Acquiring additional warehouse space will cost $600,000.
The CCA rate for buildings and warehouse space is 5% and their salvage value of at the end of the project will be 10% of the cost. The freezer will be depreciated at 30% each year and its salvage value in 10 year is negligible.
The land on which the expansion to the building is built is valued at $250,000 and Little Ceasers has completed a feasibility study recently which costed the company $30,000.
Operating expenses are expected to be 80% of sales and to secure the contract, Little Ceasers also plans to hire more staff and there will be an extra payment of $40,000 in fixed salaries each year.
To start production, Little Ceasers needs to order $200,000 food supply including cheese, flour, sausage immediately, after that, net working capital is estimated to be 11% of sales each year.
In addition to the benefit derived from increased sales, the new high-speed line will reduce plant-wide (including old operations and the proposed new capacity) unit cost by $0.019 starting from the first year.
Little Ceasers has 2,000 units of 5-year, 7% semi-annual coupon bonds, and the bond is priced to yield 6% (Yield to Maturity). The company also issued 100,000 shares of common stocks, and the market price of this stock is $50 per share, the beta of Little Ceaserss stock is 2.0. Little Ceasers also has 4,000 shares of 6% preferred stocks (assume the preferred stock has a face value of $100). The current stock price is $45 per share. Suppose the average return on 10-year Canadian government bond is 5%, and the return on TSX Composite Index is 10%.
The corporate tax rate of Little Ceasers is 38%.
- Whats the required rate of return (or cost of capital) for Little Ceasers?
- Whats the NPV of the project? And do you accept this project or not?
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