Aunt Sally's Food Inc. is considering expansion. Sally has paid $100,000 for a marketing study to assist in the potential valuation. The study indicates that the new product will have sales of $1,500,000 per year each year for the next 6 years. However, existing product line sales will be adversely affected by about $200,000 per year. Equipment will cost $1,100,000 and will be depreciated on the straight-line method with no salvage value at the end of 6 years. Annual fixed costs are $160,000 per year and variable costs are 60% of annual sales. Also, initial working capital outlay of $150,000 will be required which will be recaptured at the end of the 6 years. Sally's tax rate is 35%. The firm requires an 18% return. Sally also requires a 25% after tax return on an accounting basis.
I NEED TO FIND 1) NET PRESENT VALUE 2) INTERNAL RATE OF RETURN 3) AVERAGE ACCOUNTING RETURN
PLEASE HELP!!
To calculate the net present value (NPV), internal rate of return (IRR), and average accounting return (AAR), we will need to follow a series of steps:
Step 1: Calculate the cash flows for each year
Step 2: Calculate the present value of each cash flow
Step 3: Calculate the NPV
Step 4: Calculate the IRR
Step 5: Calculate the AAR
Let's begin with Step 1:
1) Calculate the cash flows for each year:
Year 0:
Initial working capital outlay: -$150,000
Years 1-6:
Sales from the new product: $1,500,000
Adverse impact from existing product line: -$200,000
Variable costs (60% of sales): -$900,000 ([$1,500,000 - $200,000] * 0.6)
Fixed costs: -$160,000
Depreciation: -$1,100,000 / 6 = -$183,333.33 per year
Taxable income: (Sales - Adverse impact - Variable costs - Fixed costs - Depreciation)
Tax expense: Taxable income * Tax rate
Year 6:
Sales from the new product: $1,500,000
Adverse impact from existing product line: -$200,000
Variable costs (60% of sales): -$900,000 ([$1,500,000 - $200,000] * 0.6)
Fixed costs: -$160,000
Depreciation: -$1,100,000 / 6 = -$183,333.33 per year
Taxable income: (Sales - Adverse impact - Variable costs - Fixed costs - Depreciation + Salvage value) where Salvage value = $0
Tax expense: Taxable income * Tax rate
Working capital recapture: +$150,000
Step 2: Calculate the present value of each cash flow
To calculate the present value of each cash flow, we need to discount the cash flows by the required return rate.
Step 3: Calculate the NPV
The NPV is the sum of the present values of the cash flows (including the initial investment). It represents the net value of the investment in today's dollars.
Step 4: Calculate the IRR
The IRR is the discount rate that makes the NPV equal to zero. It represents the annualized return on the investment.
Step 5: Calculate the AAR
The AAR is calculated by dividing the average annual accounting profit by the average investment.
Note: Since the question mentions Sally's requirement for a 25% after-tax return on an accounting basis, we will use a 25% required rate of return for both the NPV and AAR calculations.
Now, let's put all this information together to calculate the values:
Step 1: Calculate the cash flows for each year (refer to the calculations above)
Step 2: Calculate the present value of each cash flow
Step 3: Calculate the NPV
Step 4: Calculate the IRR
Step 5: Calculate the AAR
The calculations may be complex and require a spreadsheet or financial calculator.