Exotic Food Inc., Capital Budgeting Case CASE SUMMARY Exotic Food Inc., a food processing company located in...

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Exotic Food Inc., Capital Budgeting Case
CASE SUMMARY
Exotic Food Inc., a food processing company located in Herndon,VA, is considering adding a new division to produce fresh gingerjuice. Following the ongoing TV buzz about significant healthbenefits derived from ginger consumption, the managers believe thisdrink will be a hit. However, the CEO questions the profitabilityof the venture given the high costs involved. To address hisconcerns, you have been asked to evaluate the project using threecapital budgeting techniques (i.e., NPV, IRR and Payback) andpresent your findings in a report.
CASE OVERVIEW
The main equipment required is a commercial food processor whichcosts $200,000. The shipping and installation cost of the processorfrom China is $50,000. The processor will be depreciated under theMACRS system using the applicable depreciation rates are 33%, 45%,15%, and 7% respectively. Production is estimated to last for threeyears, and the company will exit the market before intensecompetition sets in and erodes profits. The market value of theprocessor is expected to be $100,000 after three years. Net workingcapital of $2,000 is required at the start, which will be recoveredat the end of the project. The juice will be packaged in 20 oz.containers that sell for $3.00 each. The company expects to sell150,000 units per year; cost of goods sold is expected to total 70%of dollar sales.

Weighted Average Cost of Capital (WACC):
Exotic Food’s common stock is currently listed at $75 per share;new preferred stock sells for $80 per share and pays a dividend of$5.00. Last year, the company paid dividends of $2.00 per share forcommon stock, which is expected to grow at a constant rate of 10%.The local bank is willing to finance the project at 10.5% annualinterest. The company’s marginal tax rate is 35%, and the optimumtarget capital structure is:
Common equity 50%
Preferred 20%
Debt 30%
Your main task is to compute and evaluate the cash flows usingcapital budgeting techniques, analyze the results, and present yourrecommendations whether the company should take on the project.
QUESTIONS
To help in the analysis, answer all the following questions.Present the analysis in one Excel file with the data, computations,formulas, and solutions. It is preferred that the Excel file beembedded inside the WORD document (question 8).
What are the Free Cash Flows (FCF) generated from the project?
Create a projected cash flow schedule
What is the Weighted Average Cost of Capital (WACC)?
Compute the after-tax cost of debt
Compute the cost of common equity
Compute the cost of preferred stock
Compute the Weighted Average Cost of Capital (WACC)
Using a WACC of 15%, apply four capital budgeting techniques toevaluate the project, assuming the Free Cash Flows are asfollows:
Years
Free Cash Flows
0
$ -252,000.00
1
$118,625.00
2
$127,125.00
3
$181,000.00
The four techniques are NPV, IRR, MIRR, and discounted Payback.Assume the reinvestment rate to be 8% for the MIRR. Also, assumethat the business will only accept projects with a payback periodof two and half years or less.

Answer & Explanation Solved by verified expert

3.7 Ratings (642 Votes)

1 0 1 2 3 Sales 45000000 45000000 45000000 Variable cost 31500000 31500000 31500000 Depreciation 8250000 11250000 3750000 1750000 NOI 5250000 2250000 9750000 Tax at 35 1837500 787500 3412500 Incremental NOPAT 3412500 1462500 6337500 Add Depreciation 8250000 11250000 3750000 Incremental OCF See Answer

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Transcribed Image Text

Exotic Food Inc., Capital Budgeting CaseCASE SUMMARYExotic Food Inc., a food processing company located in Herndon,VA, is considering adding a new division to produce fresh gingerjuice. Following the ongoing TV buzz about significant healthbenefits derived from ginger consumption, the managers believe thisdrink will be a hit. However, the CEO questions the profitabilityof the venture given the high costs involved. To address hisconcerns, you have been asked to evaluate the project using threecapital budgeting techniques (i.e., NPV, IRR and Payback) andpresent your findings in a report.CASE OVERVIEWThe main equipment required is a commercial food processor whichcosts $200,000. The shipping and installation cost of the processorfrom China is $50,000. The processor will be depreciated under theMACRS system using the applicable depreciation rates are 33%, 45%,15%, and 7% respectively. Production is estimated to last for threeyears, and the company will exit the market before intensecompetition sets in and erodes profits. The market value of theprocessor is expected to be $100,000 after three years. Net workingcapital of $2,000 is required at the start, which will be recoveredat the end of the project. The juice will be packaged in 20 oz.containers that sell for $3.00 each. The company expects to sell150,000 units per year; cost of goods sold is expected to total 70%of dollar sales. Weighted Average Cost of Capital (WACC):Exotic Food’s common stock is currently listed at $75 per share;new preferred stock sells for $80 per share and pays a dividend of$5.00. Last year, the company paid dividends of $2.00 per share forcommon stock, which is expected to grow at a constant rate of 10%.The local bank is willing to finance the project at 10.5% annualinterest. The company’s marginal tax rate is 35%, and the optimumtarget capital structure is:Common equity50%Preferred20%Debt30%Your main task is to compute and evaluate the cash flows usingcapital budgeting techniques, analyze the results, and present yourrecommendations whether the company should take on the project.QUESTIONSTo help in the analysis, answer all the following questions.Present the analysis in one Excel file with the data, computations,formulas, and solutions. It is preferred that the Excel file beembedded inside the WORD document (question 8).What are the Free Cash Flows (FCF) generated from the project?Create a projected cash flow scheduleWhat is the Weighted Average Cost of Capital (WACC)?Compute the after-tax cost of debtCompute the cost of common equityCompute the cost of preferred stockCompute the Weighted Average Cost of Capital (WACC)Using a WACC of 15%, apply four capital budgeting techniques toevaluate the project, assuming the Free Cash Flows are asfollows:YearsFree Cash Flows0$ -252,000.001$118,625.002$127,125.003$181,000.00The four techniques are NPV, IRR, MIRR, and discounted Payback.Assume the reinvestment rate to be 8% for the MIRR. Also, assumethat the business will only accept projects with a payback periodof two and half years or less.

Years	Free Cash Flows
0	$ -252,000.00
1	$118,625.00
2	$127,125.00
3	$181,000.00