We know that net sales for year t is equal to New sales less the lost sales less the

lost revenue, or
Net sales = Unit sales of new meal x price of new meal
-

Reduction in unit sales of existing meal x Current price of existing

meal
Reduced unit sales of existing meal x price reduction in existing
meal

Year 1 Net Sales = 2,500,000 x $15.99 600,000 x $14.99 (950,000600,000)*($14.99-$11.99)

= $29,931,000
Year 2 Net Sales = 2,000,000 x $15.99 450,000 x $14.99 (685,000-450,000)*
($14.99-$11.99)
=$24,529,500
Year 3 Net Sales = 1,800,000 x $15.99 0 x $14.99 (0-0)* ($14.99-$11.99)
=$28,782,000
Year 4 Net Sales = 1,650,000 x $15.99 0 x$ 14.99 (0-0)* ($14.99-$11.99)
=$26,383,500
Year 5 Net Sales = 1,250,000 x $15.99 0 x $14.99 (0-0)* ($14.99-$11.99)
=$19,987,500
Variable Costs = Unit sales of new meal x variable cost of new meal
-

Reduction in unit sales of existing meal x variable cost per unit of

existing meal

Year 1 Variable Cost = 2,500,000*$10.5-600,000*$6 = $22,650,000

Year 2 Variable Cost = 2,000,000*$10.5-450000*$6 = $18,300,000
Year 3 Variable Cost = 1,800,000*$10.5 = $18,900,000
Year 4 Variable Cost = 1,650,000*$10.5 = $17,325,000
Year 5 Variable Cost = 1,250,000*$10.5= $13,125,000

Depreciation will be done on a seven-year MACRS schedule, the annual deprecation

is below,
Year 1 Depreciation = $6,500,000 * 0.1429 = $928,850
Year 2 Depreciation = $6,500,000 * 0.2449 = $1,591,850

Year 3 Depreciation = $6,500,000 * 0.1749 = $1,136,850

Year 4 Depreciation = $6,500,000 * 0.1249 = $811,850
Year 5 Depreciation = $6,500,000 * 0.0893= $580,450
Net Working Capital will be 13% of the sales of that year. Therefore,
Year 0 NWC = 0 (Because no initial outlay)
Year 1 NWC = .13 * $29,931,000 = $3,891,030
Year 2 NWC = .13 * $24,529,500 = $3,188,835
Year 3 NWC = .13 * $28,782,000 = $3,741,660
Year 4 NWC = .13 * $26,383,500 = $3,429,855
Year 5 NWC = 0

Now we have,
Year 1

Year 2

Year 3

Year 4

Year 5

Net Sales

$29,931,00
0.00

$24,529,50
0.00

$28,782,00
0.00

$26,383,50
0.00

$19,987,50
0.00

Variable
Cost

(22,650,000
.00)

(18,300,000
.00)

(18,900,000
.00)

(17,325,000
.00)

(13,125,000
.00)

Fixed Costs

(850,000.00
)

(850,000.00
)

(850,000.00
)

(850,000.00
)

(850,000.00
)

Depreciatio
n

(928,850.00
)

(1,591,580.
00)

(1,136,850.
00)

(811,850.00
)

(580,450.00
)

EBT

$5,502,150.
00

$3,787,920.
00

$7,895,150.
00

$7,396,650.
00

$5,432,050.
00

Taxes(35%)

(1,925,752.
50)

(1,325,772.
00)

(2,763,302.
50)

(2,588,827.
50)

(1,901,217.
50)

Net income

$3,576,397.
50

$2,462,148.
00

$5,131,847.
50

$4,807,822.
50

$3,530,832.
50

Depreciatio
n

$928,850.0
0

$1,591,580.
00

$1,136,850.
00

$811,850.0
0

$580,450.0
0

OCF

$4,505,247.
50

$4,053,728.
00

$6,268,697.
50

$5,619,672.
50

$4,111,282.
50

Beg NWC

$3,891,030.
00

$3,188,835.
00

$3,741,660.
00

$3,429,855.
00

End NWC

(3,891,030.
00)

(3,188,835.
00)

(3,741,660.
00)

(3,429,855.
00)

NWC Cash
Flow

(3,891,030.
00)

702,195.00

(552,825.00
)

311,805.00

3,429,855.0
0

Net Cash
Flow

$614,217.5
0

$4,755,923.
00

$5,715,872.
50

$5,931,477.
50

$7,541,137.
50

The book value of the equipment is the cost less the accumulated depreciation over
the 5 years of the project. So,
Book value = $6,500,000-($928,850+$1,591,580+$1,136,850+$811,850+
$580,450) = $1,450,420
The book value is higher than the estimated market value, therefore, we need to
calculate the tax credit that we be realized on the sale of the equipment.
Tax Credit = (BV MC)(Tc)
= ($1,450,420-$85,000)(.35)
= $477,897
Cash Flow from Equipment Sale = $85,000+$477,897 = $562,897
Therefore, the final cash flows of the project are,
Year 0

-$6,500,000

Year 1

$614,217.50

Year 2

$4,755,923.00

Year 3

$5,715,872.50

Year 4

$5,931,477.50

Year 5

$8,104,034.50 ($7,541,137.50+$562,897)

1) The money spent to develop the new line of meals and the marketability
study are both sunk costs. Whether or not they decided to proceed with the
introduction of the new meals, these costs have already been incurred and
cannot be recovered. Therefore, the total amount of sunk costs for this

Year

Cum. Cash
Flow

Cash Flow
0
01
2
3
4
5

$6,500,000
$$614,217.50 5,885,782.
5
$4,755,923.
$1,129,859
00
.5
$5,715,872. $4,586,013
50
.0
$5,931,477. $10,517,49
50
0.5
$8,104,034. $18,621,52
50
4.5
$5,715,872.50
-$6,500,000

project is $150,000+$200,000 =
$350,000
2) As seen above, the cash flows for
each year are,

Year 4

$5,931,477.50

Year 5

$8,104,034.50

Year 0

-$6,500,000

Year 1
$614,217.50
Year 2
$4,755,923.00
Year 3

3) To determine the payback period, we consider the following,

(-$6,500,000+$614,217.5)
(-$5,885,782.5+$4,755,923)
(-$1,129,859.5+$5,715,872.5)
($4,586,013+$5,931,477.5)
($10,517,490+$8,104,034.50)
We see that the payback period is sometime between years 2 and 3. To
determine the actual payback period, we have,
Payback period = 2 + $1,129,859.5/$5,715,872.5 = 2.20 years.
Therefore, the project should be accepted based on payback because
the max it requires is 4.
4) Profitability Index can be given as follows,
PV = $614,217.5/(1+.12)+$4,755,923/(1+.12)^2+$5,715,872.5/
(1+.12)^3+
$5,931,477.5/(1+.12)^4+$8,104,034.50/(1+.12)^5
PV = $16,776,254.32
PI = PV / Cost = $16,776,254.32/$6,500,000=2.58
5) Internal rate of return can be given by Excel formulas as such,
Year

Cash Flow

Cum. Cash Flow

0
1
2
3
4
5

$6,500,000
$614,217.5
0
$4,755,923
.00
$5,715,872
.50
$5,931,477
.50
$8,104,034
.50

-$6,500,000
-$5,885,782.5
-$1,129,859.5
$4,586,013.0
$10,517,490.5
$18,621,525.0

Formula is
IRR
49.66% =IRR(B2:B7)
6) Net present Value is given by,
NPV = -$6,500,000+$ 614,217.5/(1+.12)+$4,755,923/(1+.12)^2+
$5,715,872.5/(1+.12)^3+
$5,931,477.5/(1+.12)^4+$8,104,034.50/(1+.12)^5
= $10,276,254,32
7) The project should be accepted based on profitability index because it is
greater than 1. The required rate of return for projects 12%, therefore by the
IRR rule with a IRR = 49.66%, this is a fantastic project to proceed forward
with. And finally, the NPV rule states that projects with a positive NPV should
be accepted and this project has a NPV that exceeds 10 million, therefore, the
project should be accepted. Hence, by all rules, this project should absolutely
be accepted.