Lee, Inc. is considering the production of a new line of soft drinks at its Springfield,...

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Lee, Inc. is considering the production of a new line of softdrinks at its Springfield, IL plant. The CFO of Lee, Inc. isprovided with the following information on the new project:
The expansion will require the immediate purchase of newmachinery for $30,000,000.
The firm has spent $1,000,000 to train workers to use the newmachinery.
The incremental sales from this project are expected to be$19,500,000 per year. The incremental
operating expenses (excluding depreciation) are expected toequal $11,300,000 per year.
The company uses straight-line depreciation. The project has aneconomic life of 10 years. The machinery has a salvage value of$1,000,000 and will be sold for that amount at the conclusion ofthe
project.
The company will increase net working capital by $1,200,000 atthe beginning of the project, and it will
be liquidated at the end of the project.
Lee Inc.’s marginal tax rate is 40%.
Lee Inc.’s weighted average cost of capital (WACC) is 10%.
Based on this information, the initial net cash flow of theproject (i.e., CF0) is $ ___.
Based on this information, the project’s operating net cash flowin year 5 is $_.
The IRR of this project is ___%.

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3.7 Ratings (567 Votes)

Time line		0	1	2	3	4	5	6	7	8	9	10



Cost of new machine		-30000000
Initial working capital		-1200000
=Initial Investment outlay		a. -31200000


Sales			19500000	19500000	19500000	19500000	19500000	19500000	19500000	19500000	19500000	19500000
Profits	Sales-variable cost		30800000	30800000	30800000	30800000	30800000	30800000	30800000	30800000	30800000	30800000


-Depreciation	Cost of equipment/no. of years		-3000000	-3000000	-3000000	-3000000	-3000000	-3000000	-3000000	-3000000	-3000000	-3000000

=Pretax cash flows			27800000	27800000	27800000	27800000	27800000	27800000	27800000	27800000	27800000	27800000
-taxes	=(Pretax cash flows)*(1-tax)		16680000	16680000	16680000	16680000	16680000	16680000	16680000	16680000	16680000	16680000
+Depreciation			3000000	3000000	3000000	3000000	3000000	3000000	3000000	3000000	3000000	3000000
=after tax operating cash flow			19680000	19680000	19680000	19680000	b. 19680000	19680000	19680000	19680000	19680000	19680000

reversal of working capital												1200000

+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)											600000
+Tax shield on salvage book value	=Salvage value * tax rate											0
=Terminal year after tax cash flows												1800000

Total Cash flow for the period		-31200000	19680000	19680000	19680000	19680000	19680000	19680000	19680000	19680000	19680000	21480000
Discount factor=	(1+discount rate)^corresponding period	1	1.626170955	2.644432	4.3002985	6.9930205	11.371847	18.492567	30.0720752	48.902335	79.52356	129.3189
Discounted CF=	Cashflow/discount factor	-31200000	12102048.64	7442051.9	4576426.5	2814234.6	1730589.6	1064211.4	654427.7329	402434.77	247473.8	166101
NPV=	Sum of discounted CF=	9.57865E-07
c. IRR is discount rate at which NPV = 0 =	62.62%

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Transcribed Image Text

Lee, Inc. is considering the production of a new line of softdrinks at its Springfield, IL plant. The CFO of Lee, Inc. isprovided with the following information on the new project:The expansion will require the immediate purchase of newmachinery for $30,000,000.The firm has spent $1,000,000 to train workers to use the newmachinery.The incremental sales from this project are expected to be$19,500,000 per year. The incrementaloperating expenses (excluding depreciation) are expected toequal $11,300,000 per year.The company uses straight-line depreciation. The project has aneconomic life of 10 years. The machinery has a salvage value of$1,000,000 and will be sold for that amount at the conclusion oftheproject.The company will increase net working capital by $1,200,000 atthe beginning of the project, and it willbe liquidated at the end of the project.Lee Inc.’s marginal tax rate is 40%.Lee Inc.’s weighted average cost of capital (WACC) is 10%.Based on this information, the initial net cash flow of theproject (i.e., CF0) is $ _______.Based on this information, the project’s operating net cash flowin year 5 is $_______.The IRR of this project is _____%.