Part $1$ Case study $(25$ marks$)$

You are placed in the role of an analyst for Hill Country Snack Food Co$.$ Hill Country Snack

Food $Co$ is considering investing in a new product, SuperBar. You have been asked by the

CEO to provide a recommendation on whether to go ahead with the investment in SuperBar.

The research and development costs so far have totalled $$40$ million $($exotic superfoods and

rare minerals of dubious origin are expensive!$).$ If approved by the CEO, SuperBar could be

put on the market at the beginning of next year $($Year $1),$ and Hill Country expects it to stay

on the market for a total of four years $($from Year $1$ to Year $4).$

If the project proceeds, the initial investment will occur immediately $($Year $0),$ and

operational cash flows will occur at beginning of next year $($Year $1).$ Hill Country must

initially invest $$1$ million in production equipment to make the SuperBar $($in Year $0).$ This

equipment can be sold for $$800,000$ at the end of four years $($Year $4).$ Hill Country would sell

the SuperBar through its current channels, so sales will be able to commence as soon as the

equipment is operational.

SuperBar is expected to wholesale for $$2$ per bar. The variable cost to produce each bar is $$1.$

In order to secure appropriate celebrity endorsement for the new SuperBar, Hill Country will

incur $$20$ million in marketing and general administration costs in the first year $($Year $1).$

Both selling price and costs $($including variable cost and marketing and general

administration cost$)$ are expected to increase at the inflation rate in the subsequent years

$($Year $2$ to Year $4).$ Hill Country's corporate tax rate is $35\mathrm{.}5$ percent. Annual inflation is

expected to remain constant at $3\mathrm{.}25$ percent over the life of the project.

Industry research suggests the following sales targets are reasonable: $30$ million bars sold in

the first year, $20$ million in year two, $15$ million in year three, and $15$ million in year four.

The production equipment would be depreciated using the straight$-$line depreciation method

over $4$ years to a zero balance. The immediate initial working capital requirement is $$1$

million in Year $0.$ At the end of Year $4,$ the company will get all working capital back.

For the purposes of this analysis, assume a $10\%$ discount rate is appropriate.

a$)$Calculate the incremental free cash flow during the project$$s life $($starting from Year $0$ to Year $4).$ Show workings. $(15$ marks$)$

b$)$Calculate the NPV$,$ payback period and IRR of the project. Should the project be accepted based on NPV rule? Show workings and explain your answer$($s$).(10$ marks$)$