â€œDo we have everything we need on sales and costs?â€ you ask. â€It must be time to compute the net present value (NPV) and internal rate of return (IRR) of the Apix expansion project.â€
â€œWe have the data from James and Luke regarding projected sales and costs, respectively, for the food packaging project,â€ says Mary. â€œIt is feasible to project that we will receive a tax break from this implementation. I have information from our audit firm that indicates that future depreciation methods for taxes will be straight-line; however, the corporate rates will be reduced to 35% as we assumed in our weighted average cost of capital (WACC) calculation.â€
â€œThat sounds good,â€ you say.
â€œRight,” says Mary. “You can use a WACC of 10% for the computation of the NPV and comparison for IRR.”
â€œIâ€™ve got the information I need from Luke and James,â€ you say. “Does this look right to you? Hereâ€™s what they gave me,â€ you say, as you hand a sheet of paper to Mary.â€œLetâ€™s look at this now while weâ€™re together,â€ she says.
The information you hand to Mary shows the following:
- Initial investment outlay of $30 million, consisting of $25 million for equipment and $5 million for net working capital (NWC) (plastic substrate and ink inventory); NWC recoverable in terminal year
- Project and equipment life: 5 years
- Sales: $25 million per year for five years
- Assume gross margin of 60% (exclusive of depreciation)
- Depreciation: Straight-line for tax purposes
- Selling, general, and administrative expenses: 10% of sales
- Tax rate: 35%
You continue your conversation.
â€œIt looks good,â€ says Mary. â€œUse this information from Luke and James to compute the cash flows for the project.â€
â€œNo problem,â€ you say.
â€œThen, compute NPV and IRR of the project using the Excel spreadsheet I sent earlier today,â€ says Mary. â€œUse the IRR financial function for the computation of IRR.â€
â€œOkay,â€ you say. “Iâ€™ll submit my Excel file showing the computation of cash flows, NPV, and IRR by the end of week so you can look at it over the weekend.â€
â€œThanks,â€ says Mary.