Question
QUESTION FOUR (20 Marks) Ross Chickens is considering building a new chicken farm to service their North Western region stores. The stores currently require 1500,000
QUESTION FOUR (20 Marks)
Ross Chickens is considering building a new chicken farm to service their North Western region stores. The stores currently require 1500,000 birds per year, and they are purchased from various local farms for an average price of K10 per bird. The managers of Ross Chickens believe that their new farm would lower the cost per bird to K7, while maintaining their average selling price of K50 per bird. However, due to the centralized structure of this operation, transporting expenses will increase to K3.50 per bird from the current average of K1.50.
In addition, the firm will need to increase its inventory of live birds by K120, 000. It is estimated that it will cost K1000, 000 to purchase the land, and K700, 000 to construct the buildings and purchase equipment. In addition, labor expenses will rise by K170, 000 per year. The buildings and equipment will be depreciated using the straight line method over five years to a salvage value of K200, 000. At the end of five years the company will sell the farm for K500, 000 (K300, 000 for the buildings and equipment and K200, 000 for the land). Assume that the firms marginal tax rate is 35 %, and note that land is not depreciable.
i. Calculate the initial outlay, annual after-tax cash flows, and terminal cash flow for this project. (6 Marks)
ii. If the Weighted Average Cost of Capital (WACC) is 13%, calculate the payback period, discounted payback period, Net Present Value (NPV), Profitability Index (PI) and Internal Rate of Return (IRR). (6 Marks)
iii. The managers of Ross Chickens are uncertain about several of the variables in your analysis and have asked you to provide three different scenarios. Create a scenario analysis showing the profitability measures for this investment using the information in the table below. (Note: The salvage value of the buildings is the actual forecasted salvage value, not the salvage value used for depreciation.) (18 Marks)
Scenario | labor | Salvage Value of Buildings | Salvage Value of Land |
Best Case | k150,000 | k180,000 | k250,000 |
Expected Case | k170,000 | k200,000 | k300,000 |
worst case | k200,000 | k250,000 | k350,000 |
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