## 05 Aug TexMex Food Company Is Considering A New Salsa Whose Data Are Shown Below

**Problem #1: **TexMex Food Company is considering a new salsa whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no change in net operating working capital would be required. Revenues and other operating costs are expected to be constant over the project’s 3-year life. However, this project would compete with other TexMex products and would reduce their pre-tax annual cash flows. What is the project’s NPV? (Hint: Cash flows are constant in Years 1-3.)

WACC 10.0%

Pre-tax cash flow reduction for other products (cannibalization) -$5,000

Investment cost (depreciable basis) $80,000

Straight-line depreciation rate 33.333%

Annual sales revenues $67,500

Annual operating costs (excl. depreciation) -$25,000

Tax rate 35.0%

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**Problem #2:** Sub-Prime Loan Company is thinking of opening a new office, and the key data are shown below. The company owns the building that would be used, and it could sell it for $100,000 after taxes if it decides not to open the new office. The equipment for the project would be depreciated by the straight-line method over the project’s 3-year life, after which it would be worth nothing and thus it would have a zero salvage value. No change in net operating working capital would be required, and revenues and other operating costs would be constant over the project’s 3-year life. What is the project’s NPV? (Hint: Cash flows are constant in Years 1-3.)

WACC 10.0%

Opportunity cost $100,000

Net equipment cost (depreciable basis) $65,000

Straight-line depreciation rate for equipment 33.333%

Annual sales revenues $123,000

Annual operating costs (excl. depreciation) $25,000

Tax rate 35%

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**Problem #3: **Desai Industries is analyzing an average-risk project, and the following data have been developed. Unit sales will be constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise with inflation. The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no salvage value. No change in net operating working capital would be required. This is just one of many projects for the firm, so any losses on this project can be used to offset gains on other firm projects. What is the project’s expected NPV?

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WACC 10.0%

Net investment cost (depreciable basis) $200,000

Units sold 50,000

Average price per unit, Year 1 $25.00

Fixed oper. costs excl. depreciation (constant) $150,000

Variable oper. cost/unit, Year 1 $20.20

Annual depreciation rate 33.333%

Expected inflation rate per year 5.00%

Tax rate 40.0%

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**Problem #4: **Poulsen Industries is analyzing an average-risk project, and the following data have been developed. Unit sales will be constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise with inflation. The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no salvage value. No change in net operating working capital would be required. This is just one of many projects for the firm, so any losses on this project can be used to offset gains on other firm projects. The marketing manager does not think it is necessary to adjust for inflation since both the sales price and the variable costs will rise at the same rate, but the CFO thinks an inflation adjustment is required. What is the difference in the expected NPV if the inflation adjustment is made versus if it is not made?

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WACC 10.0%

Net investment cost (depreciable basis) $200,000

Units sold 50,000

Average price per unit, Year 1 $25.00

Fixed oper. costs excl. depreciation (constant) $150,000

Variable oper. cost/unit, Year 1 $20.20

Annual depreciation rate 33.333%

Expected inflation 4.00%

Tax rate 40.0%

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**Problem #5: **Florida Car Wash is considering a new project whose data are shown below. The equipment to be used has a 3-year tax life, would be depreciated on a straight-line basis over the project’s 3-year life, and would have a zero salvage value after Year 3. No change in net operating working capital would be required. Revenues and other operating costs will be constant over the project’s life, and this is just one of the firm’s many projects, so any losses on it can be used to offset profits in other units. If the number of cars washed declined by 40% from the expected level, by how much would the project’s NPV change? (Hint: Note that cash flows are constant at the Year 1 level, whatever that level is.)

WACC 10.0%

Net investment cost (depreciable basis) $60,000

Number of cars washed 2,800

Average price per car $25.00

Fixed oper. costs (excl. depreciation) $10,000

Variable oper. cost/unit (i.e., VC per car washed) $5.375

Annual depreciation $20,000

Tax rate 35.0%