TEGRATED CASE ALLIED FOOD PRODUCTS CAPITAL BUDGETING AND CASH FLOW ESTIMATION Allied Food Products is considering expanding into the fruit juice business with a new fresh lemon juice product. Assume that you were recently hired as assistant to the director of capital budgeting, and you must evaluate the new project. The lemon juice would be produced in an unused building adjacent to Allied's Fort Myers plant: Allied owns the building, which is fully depreciated. The required equipment would cost $200,000, plus an additional $10,000 for shipping and installation. In addition, inventories would rise by $25.000, while accounts payable would increase by $5,000. All of these costs would be incurred at t-0. By a special ruling, the machinery could be depreciated under the MACRS system as 3-year property. The applicable 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 inflows are assumed to begin 1 year after the project is undertaken, or att1and to continue out tot 4. At the end of the project's life 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 60% 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: a. Allied has a standard form that is used in the capital budgeting process. (See Table IC 12.1.) Part of the table has been completed, but you must replace the blanks with the missing numbers. Complete the table using the following steps: 1. Fill in the blanks under Year 0 for the initial investment outlays: CAPEX and ANOWC. 2. Complete the table for unit sales, sales price, total revenues, and operating costs excluding depreciation 3. Complete the depreciation data. 4. Complete the table down to after-tax operating income and then down to the project's operating cash flows, EBIT(1 - T) + DEP. 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? c. Disregard all the assumptions made in part band assume there is no alternative use for the building over the next 4 years. Now calculate the project's NPV, IRR, MIRR, and payback. Do these indicators suggest that the project should be accepted? Explain. Allied's Lemon Juice Project (in Thousands) TABLE IC 12.1 End of Year: 100 $ 2.00 $120.0 1. Investment Outlays Equipment cost Installation CAPEX Increase in inventory Increase in accounts payable ANOWC 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 - TI + DEP III. Project Termination Cash Flows Salvage value (taxed as ordinary income) Tax on salvage value After-tax salvage value ANOWC Recovery of net operating working capital Project free cash flows EBIT(1-T) + DEP-CAPEX - ANOWC IV. Results NPV = IRR = MIRR 1724 11 Group Assignment #3 Topic: Cash Flow Estimation and Risk Analysis Refer Textbook Chapter 12: Integrated Case - Allied Food Products (pp. 444-447) You are given WACC = 10% and Tax Rate is 40% Part A: Cash Flow Estimation Complete the table by calculating CAPEX and Changes in NOWC for the years shown Complete the project's Operating Cash Flows for the years shown where Operating Cash Flow = EBIT(1-Tax Rate) + Dep Find Project Free Cash Flows for the years shown Find NPV and IRR and discuss what they imply PartRo Risk Analysis using Sensitivity Analysis N O P W g DOLL