Question

Obed Cocoa Farms (OCF) is a manufacturing firm that makes raw cocoa powder. As part of an ongoing expansion program, the company plans to purchase a new processor costing $1 million. An additional $25,000 would be required to modify the equipment for factory use. Shipping and installation charges are $1,200 and $500, respectively. The machine will be used for 4 years. Also, it will be fully depreciated using straightline method over 4 years at the end of which, it can be sold for 20% of its original value.

Once fully operational, the machine is expected to generate incremental sales of 17,000 boxes of raw cocoa powder per year for 4 years. The per unit sales price in the first year is $75. Also, in the first year, the total incremental operating cost (excluding depreciation) is projected to be 60% of total sales. Both the sales price and operating costs are expected to increase by 2% per year due to inflation.

To place the new equipment into full operation, OCF will need to increase the amount of cocoa pods it processes. Cocoa pod is the raw material used for making cocoa powder. The cost of this initial increase in raw materials is expected to be $100,000. For each of the subsequent years, net working capital (NWC) is projected to be 25% of total sales expected in the following year. For example, NWC for Year 1 = 0.25(Year 2 sales), etc.

Half of the initial investment in this project will be borrowed at an interest rate of 8.5%. A non-refundable insurance premium of $1,000 for this investment was pre-paid 2 years ago. The firm’s tax rate is 40% and the cost of capital is 12%.

1. What is the net cash flow for Year 1?

   		$183,545
   		$414,400
   		$427,400
   		$885,660

2. What is the net cash flow for Year 2?

   		$183,545
   		$414,400
   		$885,660
   		$408,288

3. What is the final net cash flow – after adjustments – for Year 4?

   		$183,545
   		$414,400
   		$885,660
   		$408,288

4. What is the NPV of this investment?

   		$183,545
   		$220,478
   		$885,660
   		None of the above

5. Calculate the Modified Internal Rate of Return (MIRR) for this project.

   		19.13%
   		17.12%
   		23.10%
   		None of the above

6. Given the pattern of this project’s cash flows, can we expect the problem of multiple IRR?

   		Yes. There is at least two changes in cash flow signs
   		Yes. The cash flow pattern is irregular and. Also, the cost of capital is less than the crossover rate.
   		No. The cash flow pattern is considered normal
   		Insufficient information

7. Consider the amount to be borrowed. Assume the loan will be amortized – monthly – for 4 years. How much is the total monthly payment?

   		$171,983.93
   		$13,885.62
   		$48,858.19
   		None of the above

Answer 1

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