Calculate free cash flows and find internal rate of return

Reference no: EM13195227

Cupcake Corp. is considering an investment of $40 million in plant and machinery. This is expected to produce sales of $23 million in year 1, $26 million in year 2, and $30 million in year 3. Subsequent sales are expected to increase by 10% each year for the remaining 2 years. The plant and machinery will be scrapped after 5 years with a salvage value of $10 million. The property and machinery belong to the 3-year recovery period class for depreciation purposes (MACRS). Cost of goods sold (COGS) is expected to be $8 million in year 1, $14 million in year 2, and to increase at 9% each year for the remaining 3 years. Fixed operating expenses are $1,000,000 per year. Year-end net working capital (NWC) is given below. The corporate tax rate is 40%.

k = 000s	0	1	2	3	4	5
NWC	500k	700k	800k	800k	500k	0

a) Calculate the free cash flows for time 0 through time 5.

b) Calculate the net present value (NPV) for a 12% cost of capital.

c) Find the internal rate of return (IRR).

d) Calculate the sensitivity of the investment to a change in the cost of capital (it could be as low as 8% or as high as 16%).

e) Should Cupcake make the investment? Why or why not?

Reference no: EM13195227

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