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.
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.
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. (We calculated a monthly expected return for the market
in the return exercise. You can simply multiply that rate by 12 for an expected annual rate on the
market.) The WACC is then calculated using this information and the other information provided
above. 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.