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Case: 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 $4 million and which it currently rents out for $110,000. 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 $1.3 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 eight years and to sell the machines and equipment for $570,000. ? Finally, the project requires an initial investment into net working capital equal to 10 percent of predicted? first-year sales. ? Subsequently, net working capital is 10 percent of the predicted sales over the following year. Sales of protein bars are expected to be $4.8 million in the first year and to stay constant for eight years. Total manufacturing costs and operating expenses? (excluding depreciation) are 80 percent of? sales, and profits are taxed at 30 percent.
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?
How is IRR useful in determining whether a project will be undertaken, given that the inputs are estimates of future cash flows? Does NPV give comparable information?
The Books definition of financial leverage is " The use of debt in a firm's capital structure is called financial leverage.
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