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ALLIED FOOD PRODUCTS 12-23 the fruit juice business with a new fresh lemon juice product. Assume that you were recently hired as CAPITAL BUDGETING AND CASH FLOW ESTIMATION Allied Food Products is considering expanding into The lemon juice would be produced in an unused building adjacent to Allied's Fort Myers plant: ruling, the machinery could be depreciated under the MACRS system as 3-year property. The applicable assistant to the director of capital budgeting, and you must evaluate the new project. Allied owns the building, which is fully depreciated. The required to presentowi eost 200,000, put an additional $40,000 for shipping and installation. In addition, inventories would rise by $25,000, while , By depreciation rates are 33%, 45%, 15%, and 7%. The project is expected to operate for 4 years, at which time it will be terminated. The cash tot 4. At the end of the project's life (t = 4), the equipment is expected to have a salvage value of $25,000 Unit sales are expected to total 100,000 units per year, and the expected sales price is $2.00 per unit. Cash operating costs for the project (total operating costs less depreciation) are expected to total 67% of dollar sales Allied's tax rate is 40%, and its WACC is 10%. Tentatively, the lemon juice project is assumed to be of equal risk to Allied's other assets. You have been asked to evaluate the project and to make a recommendation as to whether it should be accepted or rejected. To guide you in your analysis, your boss gave you the following set of tasks/ questions: required adjustment affect the deci Allied's Lemon Juice Project (in thousands) TA 2 3 0 End of Year: 1. Investment Outlays Equipment cost Installation CAPEX Increase in inventory Increase in accounts payable ANOWC 100 $ 2.00 $ 2.00 $ 200.0 $120.0 36.0 16.8 $199.2 $228.0 $44.0 0.3 25.3 II. Project Operating Cash Flows Unit sales (thousands) Price/unit Total revenues Operating costs excluding depreciation Depreciation Total costs EBIT (or operating income) Taxes on operating income EBIT (1 - T) = After-tax operating income Add back depreciation EBIT (1 - T) + DEP III. Project Termination Cash Flows Salvage value (taxed as ordinary income) Tax on salvage value After-tax salvage value ANOWC - Recovery of NOWC Project free cash flows = EBIT(1 - T) + DEP - CAPEX - ANOWC S 26.4 36.0 79.2 $ 0.0 $ 79.7 II $ 54.7 (5 260.0) II $ 89.7 IV. Results NPV IRR = MIRR = b. 1. Allied uses debt in its capital structure, so some of the money used to finance the project will be debt. Given this fact, should the projected cash flows be revised to show projected interest charges? Explain 2. Suppose you learned that Allied had spent $50,000 to renovate the building last year, expensing these costs. Should this cost be reflected in the analysis? Explain. 3. Suppose you learned that Allied could lease its building to another party and earn $25,000 per year. Should that fact be reflected in the analysis? If so, how? 4. Assume that the lemon juice project would take profitable sales away from Allied's fresh orange juice business. Should that fact be reflected in your analysis? If so, how? Tiad
