As a new financial analyst at the firm- is to evaluate the project and prepare an analysis

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Question:

As a new financial analyst at the firm- is to evaluate the project and prepare an analysis to present to the board of directors. You can choose to present a slide deck of up to 20 slides or a word document of 6 pages or less (in addition to the required Excel file). Your analysis should include the items from the Capital Expenditure Proposal Template from the last case.

You have been instructed to evaluate the product based on a five year product life as it is unclear what demand for such products would be after this point. Production of the juice is planned for a currently unused section of the main plant that was recently renovated at a cost of $450,000. While the site is currently not in use the accounting staff estimates that that the space could be leased out for $175,000 per year. Required machinery costs $1,750,000 and would cost $75,000 to ship and install. It falls into the 3 year MACRS class. The best estimate of salvage value at the end of five years is $250,000. Based on other product lines, investment in operating working capital is likely to be approximately 10% of expected revenues.

The marketing department estimates that the firm can sell 1,000,000 16 ounce cartons of juice annually at a price of $4.00 per carton. Fixed costs are estimated at $750,000 and variable costs at $1.75 per unit. However, it is likely that the introduction of this product will lead to lost sales of about $450,000 on existing product lines (these lines have a pre-tax profit margin of about 30%). The marketing department has informed you that product acceptance may be as much as 30% above or below expectations and may increase by 10% per year the first few years but that demand may ultimately decrease if competitors copy the product. The firm is projecting variable costs to increase at 3.5% per year and fixed costs to increase at 2.5% per year. Marketing believes that any increases in variable costs can be passed along to consumers but management is not certain this is a viable strategy in the current market. Evaluate the project and perform sensitivity and scenario analysis.

Remember in the worst case scenario that it may make sense for the firm to abandon the project. Assume that this can be done at the end of year 2 for a cost of $500,000, net of the cash flows brought in from salvage value on the equipment. Another option management is considering is to test the product further at a cost of $450,000. This would allow management to determine more accurately the expected unit sales.

The marketing manager believes that by delaying for a year and conducting the test that management would be able to narrow the expected unit sales to within plus or minus 10,000 cartons per year. A drawback of delaying entry is that rival firms might introduce a similar juice and capture market share.

Factors to consider:

 The firm’s marginal tax rate is 35% and its weighted average cost of capital is 11% but some top managers believe the project is riskier than the firm’s typical project.

 Management has a history of underestimating sales.