Question

TexMex Food Company is considering a new salsa whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no change in net operating working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life. However, this project would compete with other TexMex products and would reduce their pre-tax annual cash flows. What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.)  Do not round the intermediate calculations and round the final answer to the nearest whole number.

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WACC	10.0%
Pre-tax cash flow reduction for other products (cannibalization)	-$5,000
Investment cost (depreciable basis)	$80,000
Straight-line depr. rate	33.333%
Annual sales revenues	$66,000
Annual operating costs (excl. depr.)	-$25,000
Tax rate	35.0%

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	a.	01,684
	b.	01,403
	c.	01,529
	d.	01,347
	e.	01,094

Answer 1

The NPV is computed as shown below:

The annual cash flow is computed as follows:

= (Sales revenue - Cannibalization cost - operating cost excluding depreciation - depreciation) x (1 - tax rate) + depreciation

= ($ 66,000 - $ 5,000 - $ 25,000 - $ 80,000 x 33.333%) x (1 - 0.35) + $ 80,000 x 33.333%

= $ 6,066.6645 + 26,666.67

= $ 32,733.3345

So, the NPV will be computed as follows:

= - $ 80,000 + $ 32,733.3345 / 1.10 + $ 32,733.3345 / 1.102 + $ 32,733.3345 / 1.103

= $ 1,403 Approximately