Question content area top

Part $1$

Arnold Inc. is considering a proposal to manufacture$$ high$-$end protein bars used as food supplements by body builders. The project requires use of an existing$$ warehouse, which the firm acquired three years ago for $$$$3$ million and which it currently rents out for $$$$104$ comma $000.$ Rental rates are not expected to change going forward. In addition to using the$$ warehouse, the project requires an upfront investment into machines and other equipment of $$$$1\mathrm{.}20$ million. This investment can be fully depreciated$$ straight$-$line over the next $10$ years for tax purposes.$$ However, Arnold Inc. expects to terminate the project at the end of $8$ years and to sell the machines and equipment for $$$$542$ comma $000.$Finally$,$ the project requires an initial investment into net working capital equal to$10\%$ of predicted$$ first$-$year sales.$$ Subsequently, net working capital is$10\%$ of the predicted sales over the following year. Sales of protein bars are expected to be $$$$4\mathrm{.}60$ million in the first year and to stay constant for $8$ years. Total manufacturing costs and operating expenses$($excluding depreciation$)$ are$80\%$ of$$ sales, and profits are taxed at $35\%.$

a$.$ What are the free cash flows of the$$ project?

b$.$ If the cost of capital is $15\%,$ what is the NPV of the$$ project?