Allied Food Products

7/28/2019 Allied Food Products

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Allied Food Products: Lemon Juice Project

End of Year 0 1 2 3 4

I. Investment Outlay

Equipment cost ($200)

Installation (40)

Increase in inventory (25)

Increase in accounts payable 5

Total net investment (260)

II. Project Operating Cash Flows

Unit sales (thousands) 100 100 100 100

Price/unit $ 2.00 $ 2.00 $ 2.00 $ 2.00

Total revenues $200.0 $200.0 $200.0 $200.0

Operating costs, excluding depreciation $120.0 $120.0 $120.0 $120.0Depreciation 79.2 108.0 36.0 16.8

Total costs $199.2 $228.0 $156.0 $136.8

Operating income before taxes

(EBIT)

$ 0.8 ($ 28.0) $ 44.0 $ 63.2

Taxes on operating income 0.3 (11.2) 17.6 25.3

After-tax operating income $ 0.5 ($ 16.8) $ 26.4 $ 37.9

Depreciation 79.2 108.0 36.0 16.8

Project operating cash flows $ 0.0 $ 79.7 $ 91.2 $ 62.4 $ 54.7

III. Project Termination Cash Flows

Return of net working capital 20.0

Salvage value 25.0Tax on salvage value (10.0)

Total project termination cash flows $ 35.0

IV. Project Net Cash Flows

Project net cash flows ($260.0) $ 79.7 $ 91.2 $ 62.4 $ 89.7

Cumulative cash flows for payback (260.0) (180.3) (89.1) (26.7) 63.0

Compounded inflows for MIRR: 106.1 110.4 68.6 89.7

Terminal value of inflows: 374.8

V. Results

NPV = -$4.0

IRR = 9.3%

MIRR = 9.6%

Payback = 3.3 years


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A) Depreciation Data: In thousands

3)Year 1 0.33 $240 = $ 79.2Year 2 0.45 $240 = 108.0

Year 3 0.15

$240 = 36.0Year 4 0.07 $240 = 16.81.0 $240.0

A)

5)

Working Capital is recovered at the end of the 4th year. If machinery had been sold for less

than book value the tax effect would be negative.

B)

1)

Projected cash flows shouldnt be revised in the table to show interest charges because the cost

of capital shows the effects of debt financing. The cost of capital is used to discount cash flows.

2)

The renovation represents a sunk cost and would not be included in the analysis.

3)

The lease payment of 25K is an opportunity cost and would be reflected in the analysis: 25K(.6)

= 15K. This amount should be subtracted from the cash flows the company has.

4)

The analysis would reflect the decreased sales from the new product. The lemon juice product

will adversely affect the orange juice sector of the business, representing an overstatement of the

lemon juice sector. The lemon juice project figures need to be reduced by the amount of

decreased revenues as it applies to the orange juice sector.


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C)

0 1 2 3 4

10% | | | | |

(260) 79.7 91.2 62.4 89.7

NPV = -$4.0. NPV is negative. Therefore, dont accept.

IRR = 0

IRR = 9.3%. The IRR is less than the cost of capital. Therefore, dont accept.

MIRR = 9.6%. The MIRR is less than the cost of capital. Therefore, dont accept.

Payback: Year Cash Flow Cumulative Cash Flow

0 $260.0 $260.0

1 79.7 180.3

2 91.2 89.1

3 62.4 26.7

4 89.7 63.0

Payback = 3 years + $26.7/$89.7 = 3.3 years.

Allied Food Products should not move forward on this project based on the above

figures.

D)

Assuming that this project had been a replacement, the analysis would look at the differences in

cash flows of taking on the project as opposed to not taking on the project. The cash flow table

would have to show a column for no change, a column for the new project and a column for the

differences which be useful in gathering the NPV, IRR and MIRR.

E)

1)

a. Within firm risk represents the total risk given to the project. Within firm risk takes into account

the NPVs standard deviation and the projects cash returns as they relate to the returns for the rest


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of the business. Within firm risk is quantified by the beta of the projects ROA compared to the

firms ROA.

b. Stand alone risk represents the projects total risk as if it were a stand alone project. Stand alone

risk is measured by the projects coefficient of variation of NPV or by the projects standard

deviation.

c. Market risk examines the risk of the project as it pertains to a diversified investor and measured

by the projects beta coefficient, taking into consideration corporate risk and stockholder

diversification.

2)

Market risk is more relevant for capital projects because it takes into consideration maximizing

shareholder wealth.

3)

Stand alone risk is the easiest to measure and it is used in budgeting decisions.

4)

Yes, the three types of risk are highly correlated because the majority of a firms projects are a part

of its core business.

F)

1)

Sensitivity analysis is a quantitative measurement of a variable on a specific projects NPV. All but

one variable is set at their expected values. This variable is altered and the outcome is compared to

the projects NPV.

2)

Using 100 as the base case value for unit sales, simply subtract 10%, 20% & 30% from 100 and

add these percentages to 100, giving you a range from 70 to 130 units. Place the sales numbers one


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at a time in the table and calculate the change in sales units, which would be reflected in various

net cash flow values. With net cash flow values, calculate the NPV, IRR, MIRR and payback.

Repeat the same steps for the sensitivity analysis on salvage value and for cost of capital analysis.

3)

The primary weakness of sensitivity analysis are that it doesnt take into consideration the effects

of diversification and it doesnt take into account information regarding projection errors and

attribute project risk to a project with long term fixed revenues. The advantage of sensitivity

analysis is that it points out variables most profitable to the firm.

Allied Food Products

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