THE FRESH AND FROZEN FISH COMPANY HAS AN EXPANSION IDEA.

THE FRESH AND FROZEN FISH COMPANY CURRENTLY MARKETS FROZEN FISH FILLETS
AND OTHER RELATED PRODUCTS. THE FIRM, SEEKING EXPANSION IDEAS, HAS DECIDED TO LOOK
INTO THE POSSIBILITY OF A LINE OF FROZEN CATFISH FILLETS.
ENTRY INTO THIS BUSINESS WOULD REQUIRE THE PURCHASE OF AN EXISTING 80-ACRE CATFISH FARM IN WESTERN ALABAMA.
THE LAND WOULD COST $250,000 AND ANOTHER $400,000 FOR THE BUILDINGS AND EQUIPMENT.
THE FIRM USES A WELL KNOWN INVESTMENT BANKER TO ASSIST IN THE ANALYSIS OF THIS EXPANSION IDEA:
THE BUILDINGS AND EQUIPMENT WILL BE DEPRECIATED USING MACRS WITH A USEFUL LIFE OF 20 YEARS.
EXPECTATION IS THAT THE FARM WILL BE SOLD , AT THE END OF FIVE YEARS, FOR $550,000; $350,000 FOR THE LAND AND $200,000 FOR THE BUILDINGS AND
IT IS ESTIMATED THAT THE FIRM WILL BE ABLE TO SELL 200,000 POUNDS OF CATFISH FILLETS AT AN AVERAGE PRICE OF $2.50 PER POUND DURING THE FIRST YEAR.
UNIT DEMAND IS EXPECTED TO GROW AT A RATE OF 8% ANNUALLY THEREAFTER.
VARIABLE OPERATING EXPENSES ARE EXPECTED TO AVERAGE 60% OF GROSS SALES, AND FIXED COSTS (NOT INCL. DEPRECIATION) WILL BE $80,000 PER YEAR.
THE FIRM'S MARGINAL TAX RATE IS 35% AND ITS COST OF CAPITAL IS 10% .

ASSIGNMENT: WE WANT TO ANALYZE THE RISK OF THIS EXPANSION PROJECT.

WE SHOULD BEGIN, THEREFORE, BY CREATING A SPREADSHEET TO DETERMINE ITS ANNUAL COSTS, ANNUAL AFTER TAX CASH FLOWS, PROJECT NPV / IRR.
THE BEST WAY TO MOVE FORWARD WITH A PROBLEM SUCH AS THIS IS TO TAKE THE GIVEN DATA AS IT COMES AND ENTER INTO A SPREADSHEET CAREFUL TO LABEL EVERY ROW.
THEN TO PROJECT BEFORE TAX AND AFTER TAX CASH FLOWS, FROM YEAR 1 TO YEAR 5; FINALLY COMPUTING THE PROJECT AFTER TAX NPV AND IRR.
SPREADSHEET: DETERMINATION OF COSTS AND ANNUAL CASH FLOWS; AFTER TAX NPV AND IRR
YEAR END YEAR END YEAR END YEAR END YEAR END YEAR END
0 1 2 3 4 5
COST OF LAND ? ?
COST OF BLDGS & EQUIP ? ?
BOOK VALUE OF BLDGS&EQUIP ? ? ? ? ?
SALES REVENUE ? ? ? ? ?
PRICE PER POUND ? ? ? ? ? 2.50
UNITS SOLD ( CATFISH LBS ) ? ? ? ? ? 200,000
UNIT SALES GROWTH RATE ? 60%
VARIABLE COSTS (% OF SALES REVE ? ? ? ? ? ?
FIXED COSTS ? ? ? ? ?
MACRS: DEPREC EXPENSE 20-YR % 3.75% 7.22% 6.68% 6.18% 5.71%
MACRS: DEPREC EXPENSE ? ? ? ? ?
TAXABLE CASH FLOWS ? ? ? ? ?
TAX RATE 35% 35% 35% 35% 35%
TAXES ? ? ? ? ? SELL LAND + BLDGS&EQUIP:

ATCF ? ? ? ? ? ATCF ON LAND= ATCF ON BLDG= TOTAL

ANNUAL CF ? ? ? ? ? ? ? ? ?
COST OF CAPITAL = 10.0%
NPV= ?
IRR= ?
RISK PREMIUM (IRR - COST OF CAPITAL)= ?

NOTES:

MACRS: DEPREC EXPENSE 20-YR % GIVEN

MACRS: DEPREC EXPENSE MACRS % * COST OF BLDGS & EQUIP

BOOK VALUE OF BLDGS&EQUIP INITIAL COST - ACCUMULATED DEPRECIATION

PRICE PER POUND FIXED AT $2.50 / LB

UNITS SOLD ( CATFISH LBS ) YEAR1 = 200,000 THEN INCREASES BY 8% / YEAR

SALES REVENUE PRICE PER LB * UNITS SOLD (LBS)

FIXED COSTS 80,000 PER YEAR

VARIABLE COSTS (% OF SALES REVENUE) 60% OF REVENUE EACH YEAR

TAXABLE CASH FLOWS PER YEAR = REVENUE - FIXED COSTS - VARIABLE COSTS - DEPRECIATION

TAX RATE 35% PER YEAR

TAXES PER YEAR = TAXABLE CASH FLOW * TAX RATE

AFTER TAX CASH FLOWS PER YEAR = TAXABLE CASH FLOW - TAX + DEPRECIATION

DEPRECIATION IS ADDED BACK SINCE IT IS NOT AN ACTUAL CASH OUTFLOW

PER YEAR = (REVENUE - FIXED COST - VARIABLE COST -DEPRECIATION )*(1 - TAX RATE) + DEPRECIATION

SAME AS , PER YEAR = (REVENUE - FIXED COSTS - VARIABLE COSTS) * (1 - TAX RATE) + DEPRECIATION * TAX RATE

SELL LAND: YEAR 5 AFTER TAX CASH FLOW = SALE PRICE - (SALE PRICE - COST)*TAX RATE

SELL BLDGS & EQUIP: YEAR 5 AFTER TAX CASH FLOW = SALE PRICE - (SALE PRICE - BOOK VALUE)*TAX RATE

ANNUAL CASH FLOWS YEAR 0 = - INITIAL PROJECT COSTS; YEAR 5 = AFTER TAX CASH FLOW + CASH INFLOW FROM SALE OF LAND + BLDGS&EQUIPMENT
COST OF CAPITAL REQUIRED RETURN = DISCOUNT RATE
NPV NET PRESENT VALUE OF ALL PROJECT CASH FLOWS
IRR INTERNAL RATE OF RETURN, PROJECT GROWTH RATE SUCH THAT NPV = 0 ; PROJECT BREAKEVEN RATE
RISK PREMIUM (IRR - COST OF CAPITAL) THE PROJECT RETURN, SPREAD, OVER AND ABOVE WHAT IS REQUIRED TO BREAKEVEN
 2.50
200,000
60%
 2.25
125,000
65%
 2.65
275,000
55%
STEP 2.
MANY UNCERTAIN VARIABLES EXIST IN OUR CATFISH PROBLEM.
WE WANT TO DETERMINE WHICH HAVE THE MOST IMPACT ON THE NPV / IRR .
FOR EXAMPLE, REDUCE THE SELLING PRICE OF LAND - 10% AND NOTE THAT IRR DROPS FROM 13.8% TO 13.2% .
WHEREAS REDUCE THE PRICE PER POUND , FROM $2.50 TO $2.25, WE FIND THE IRR DROPS FROM 13.8% TO 11.4% .

QUESTION: DETERMINE WHICH HAVE THE MOST IMPACT ON NPV ?

SET UP SEVERAL DATA TABLES BASED ON PERCENT CHANGES OF OUR UNCERTAIN VARIABLES,
GRAPHIC COMPARISON IS HELPFUL.