Wade Beverage Products is considering expanding into the fruit juice business with a new fresh pomegranate juice product. Assume that you were recently hired as assistant to the director of capital budgeting and you must evaluate the new project.
The pomegranate juice would be produced in an unused building adjacent to Wade's Fort Myers plant; Wade owns the building, which is fully depreciated. The required equipment would cost $400,000, plus an additional $50,000 for shipping and installation. In addition, inventories would rise by $40,000, while accounts payable would increase by $25,000. All of these costs would be incurred at t = 0. The machinery would be depreciated on a straight-line basis.
The project is expected to operate for 5 years, at which time it will terminated. The cash inflows are assumed to begin 1 year after the project is undertaken, or at t=1, and to continue out to t= 5. At the end of the projects life (t=5), the equipment is expected to have a salvage value of $25,000.
Unit sales are expected to total 100,000 units per year, and the expected sales price is $2.00 per unit. Cash operating costs for the project (total operating costs less depreciation) are expected to total 70% of dollar sales. Wade's tax rate is 40%, and its WACC is 12%. Tentatively, the pomegranate juice project is assumed to be of equal risk to Wade's other assets.
Required:
a) Determine the net present value of the project.
b) Determine the payback period of the project.
c) Determine the internal rate of return of the project.
d) Do you recommend that the project be undertaken? Explain.