Pistachio inc. is thinking of building a bakery to introduce French cookies, so-called macaroons, to the Newark market. A preliminary marketing study, which cost $75,000 and which was completed last year, showed significant demand for macarons in the Newark area. The bakery is expected to last for 25 years. Its initial cost is $220,000 this cost can be depreciated over 15 years using straight line depreciation. The salvage value of the equipment in the bakery after 15 years is $20,000. After 15 years the bakery can be renovated. The cost of the renovation will be $80,000 and can be depreciated (again using straight line depreciation) over the remaining 10 years of the bakery's life. The salvage value of the equipment after the remaining 10 years will be $10,000. The land the bakery is built on could be rented out for $12,500 a year for 25 years.
The bakery will be able to produce 75,000 macaroons a year. The price of a macaroon is currently $1.55. It is expected to grow at a rate of 5% per year for the first 2 years, then at 2% per year for 6 years and finally stays the same thereafter for the remainder of the bakery's life. Pistachio, INc expects to be able to sell all the macaroons that it can produce. The basic ingredients for a macaroon currently (t=0) cost $0.25 these costs are expected to grow by 1% through the lifetime of the project. The labor required to operate the bakery is expected to cost a total of $45,000 dollars in t=1 and this is expected to increase 4% thereafter. There is no working capital requirement.
The firm's total tax rate including local taxes is 36%. Pistachio Inc expects to make substantial profits on its other products so that it can offset any losses on the bakery for tax purposes.
1. Construct a spreadsheet in EXCEL to find annual cash flows of the macaroons project. All cash flows occur at year's end.
2. Currently the firm's market cap is $800 million. Its equity beta is 1.25 It also has 200 million debt outstanding. The total amount of interest paid on its debt each year is 5 million. The risk free rate is 5% and market risk premium is 8. What's the weighted average cost of capital for the firm?
3. What's the NPV of the project?