Question

Frito Lay is considering a new line of potato chips. This will be a two year project.

a. Frito Lay paid $1,000,000 last year to a winning person who thought of the new line of potato chips.

b. New equipment for the factory line will cost $12,000,000 and depreciation is by the 5-year MACRS method. Purchase of the equipment will require an increase in net working capital of $600,000 at time 0 (which will be recaptured at the end of the project).

c. The new potato chips will generate an additional $6,000,000 in revenues in the first year and $4,000,000 in revenues in the second year.

d. In addition to the additional revenues outlined in c. The new potato chips will decrease existing chip line revenues by $2,000,000 the first year. There will not be any effect in the second year.

e. The new project is estimated to have expenses of $150,000 each year.

f. At the conclusion of the project, the equipment can be sold for $7,000,000.

g. The firm’s marginal tax rate is 20 percent, and the project’s cost of capital is 7 percent.

Please answer all questions in full detail. (show steps on finance calculator)

thank you!

The following is the MACRS Depreciation Table: Year 3-year 5-year 7-year 33.33% 20.00% 14.29% 44.44% 32.00% 24.49% 14.82% 19.20% 17.49% 7.41% 11.52% 12.49% 11.52% 8.93% 5.76% 8.93% 8.93% 4.45%

Answer 1

Terminal Cash Flow without OCF

Terminal Cash Flow = After Tax Salvage from Equipment Disposal + Change in Working Capital

After Tax Salvage from Equipment Disposal = Salvage Value – Tax (Salvage Value – Book Value)

=7,000,000 - 0.20(7,000,000 - 5,760,000) = 6,752,000

Change in Working Capital = 600,000

Terminal Cash Flow = 6,752,000 + 600,000 = 7,352,000

Initial Investment in the Project

Initial Investment in the Project = Initial Capex + Change in Working Capital

= 12,000,000 + 600,000 = 12,600,000

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