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Wake Beverage Company 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 Wake’s Tampa plant; Wake owns the building, which is fully depreciated. The required equipment would cost $500,000, plus an additional $100,000 for shipping and installation. In addition, inventories would rise by $40,000, while accounts payable would increase by $15,000. All of these costs would be incurred now. The machinery would be depreciated on a straight-line basis.
The project is expected to operate for 6 years, at which time it will be terminated. The cash inflows are assumed to begin one year after the project is undertaken. At the end of the project’s life (t=6), the equipment is expected to have a salvage value of $75,000.
Unit sales are expected to total 200,000 units per year, and the expected sales price is $3.00 per unit. Cash operating costs for the project (total operating costs less depreciation) are expected to total 70% of dollar sales. Wake’s tax rate is 30%, and its WACC is 12%. Tentatively, the lemon juice project is assumed to be of equal risk to Wake’s other assets.
a) Determine the net present value of the project.
b) Determine the payback period of the project.
c) Determine the internal rate of return of the project.
d) Do you recommend that the project be undertaken? Explain