Reference no: EM133073636

The objective of this homework activity is to encourage students to use Excel spreadsheets to aid a capital budgeting problem, and to analyze how the market impounds new information into stock prices.

Candy Crash is currently in negotiation with a large supermarket chain, Costca Limited, to supply its confectionery in a private label for Costca. Under the terms, Candy Crash is expected to supply confectionery to Costca every year for the next ten years.If Candy Crash proceeds with the supply of confectionery, the company needs to purchase machinery to cope with the increase in production. New machinery is expected to cost $3,000,000,with an additional $500,000 installation and shipping costs. The machinery is expected to havea working life of 10 years. The company's accounting policy is to depreciate using the straightline approach of 8% per year. It is expected that the new machinery can be sold for $150,000at the end of its useful life.If Candy Crash is to proceed with the supply of confectionery to Costca, it is expected that the yearly operating revenues would increase by $3,000,000 in year one. From year two onwards,it is expected that the increase in yearly operating revenues would grow at a rate of 6% per annum. Total variable costs associated with the increased production would be 65% of the increase in yearly operating revenues. The fixed costs associated with the increased production are expected to be $300,000 per year. However, as the private label confectionery's selling price is cheaper than Candy Crash's brand, it is expected that Candy Crash's existing operating revenues would fall by $500,000 per annum and existing operating costs would decrease by$325,000 per annum if Candy Crash proceeds with the supply of confectionery. Moreover, there would be an initial increase in net working capital of $300,000. From year one to year nine, networking capital is expected to increase by $20,000 per year. All the net working capitals can be recovered at the end of the project's life. Given that this project's risk level is not significantly different, you believe that it is appropriate to use the existing WACC of 13.5%. The company's capital structure has remained fairly stable, with a debt-to-equity ratio of 0.8. The company has no plan to adjust its capital structure in the future. The company tax rate is 30%. Furthermore, the CEO suggests conducting sensitivity analysis as follows because of uncertainty in relation to some of the expected cash flows:

1. Allow for a 20% probability that incremental revenues associated with the supply of private label confectionery would be 30% lower than expected starting from year six;

2. Allow for a 20% probability that incremental revenues associated with the supply of private label confectionery would be 30% higher than expected starting from year six.

You are required to Show the various cash flows based on the different scenarios; assuming that the Candy Crashdecides to proceed with the supply of private label confectionery to Costca; taking into consideration of the various scenarios. You should also clearly state any assumptions (if any) made in your analysis. Based on your analysis, is this project a good investment project for CandyCrash?