After seeing Snapple’s success with noncola soft drinks and learning of Coke’s and Pepsi’s interest, A-Plus Foods Inc., (APF) has decided to consider an expansion of its own in the fruit juice business. The product being considered is fresh lemon juice. Assume that you were recently hired as assistant to the director of capital budgeting, and you must evaluate the new project. You have collected information on APF’s existing capital structure, about the new project, and what it will cost to implement the project. About the new project: The lemon juice will be produced in an unused building adjacent to APF’s Tampa plant. APF already owns the building, which is fully depreciated. The required equipment to produce the juice will cost $100,000, plus an additional $20,000 for shipping and installation. The new equipment can be depreciated under the MACRS system as a 3-year asset (rates = 33.33%, 44.45%, 14.81%, and 7.41%). APF is expected to run the project for 4 years only. At the end of the project, APF expects the equipment to have a salvage value (selling price) of $50,000. Because of this project, APF’s sales will increase by $200,000 and operating costs will increase by $120,000. APF’s tax rate is 40%. The lemon juice project is assumed to be of equal risk to APF’s other assets. About AFP’s capital structure: APF does not expect to ever issue preferred stock. Information on APF’s debt and common stock: Debt: 6% coupon bonds, $1,000 par value, 10 years remaining to maturity, selling for 90 percent of par; the bonds make semiannual payments. 5,000 bonds outstanding. Common stock: selling for $42.35 per share, next dividend will be $3.60, expected to grow at 4.5% indefinitely. The company’s beta for its common stock is 1.12. To compute a cost for common equity, the director of capital budgeting would like you to use the average of the cost using the capital asset pricing model and the cost using the dividend growth model. 200,000 shares of common stock outstanding. Other information (not company specific): The U. S. Treasury bill rate is 4%, and the market risk premium has averaged 9% in recent years.

a. What will be the change in AFP’s firm value if the project is undertaken? 

b. Should the project be undertaken? 

c. Approximately, how much will the price of one share of stock change if the project is undertaken?

Answer rating: 100% (QA)

The net present value NPV has to be calculated first so that we can identify the effect of the proje... View the full answer