50.1K

Verified Solution

Link Copied!

You had spent several months exploring the market in search of a good investment opportunity and paid around $250,000 consultation fees. Finally, you decided to establish a factory producing soft drinks to be sold to retailers. You plan to stay in this business for 10 years only and then search for another opportunity. To start up your business, you find two factories, one of them is fully automated and the other is semi-automated. Each factory requires one year to install and made ready for production (treat this year as year 0). The first factory costs $2,000,000 to buy, shipment and installation costs of this factory are $100,000. The Factory has a useful life of 10 years and its salvage value by the end of its useful life is expected to be zero and its annual operating cost is $250,000 expected to increase by 4% per annum. The second factory costs $1,500,000, shipment and installation costs are $200,000, has a useful life of 17 years, its annual operating cost is $350,000 also expected to increase by 4% per annum. The salvage value of this factory is expected to be $250,000 by the end of your investment horizon. The two factories will be depreciated using the straight-line method.

There are other soft-drink firms in the market that have similar risk to your business. The average expected rate of return on their stocks is 15%. Assume the tax rate is 30%.

A. Which factory should you choose?

After you had set up your chosen factory, in the first year of production you spent another $200,000 to analyse the market and estimate the demand. The demand for soft drinks is expected to be 500,000 cartons (each carton contains 6 bottles) in the first year of operation, and then it is expected to increase by 10% every year during the next 5 years and then to level out at 5% for the foreseeable future because other envious competitors are expected to copy your soft drink formula. The wholesale price of soft drinks in the first year of operations is expected to be $6/Cartons and the retail price is $12/Cartons, and each price is expected to increase by 4% per annum hence after. Buying the materials to produce your soft drink formula in the first year of operation is expected to cost $3/Cartons and is expected to increase by 4% per annum. You are planning to sell your soft drinks on cash, but to meet sudden demands you want to keep every year an inventory that is equal to 25% of the following years sales.

B. Based on you answer in Part A and the information given above, what are the NPV and the IRR of this project?

Answer & Explanation Solved by verified expert

See Answer