Given that its food packaging customers have been inquiring about its ability to supply complementary products, Apex is considering coffee packaging as an additional diversification to its product line. You are able to catch James in Luke's office and stop in to ask for their reaction to the query.
"Hi," you say. "I've got a quick question for you both. May I interrupt for just a minute?"
"Sure," says Luke. "What's up?"
"I need to calculate the net present value (NPV) for the coffee packaging project-the coffee packaging production equipment and a lamination machine that will bond plastic substrates for airtight quality. Does the coffee packaging line make sense for us?"
"The process will be challenging, initially," says Luke. "But once our employees acclimate, I anticipate a very efficient process. I'm certain we will be competitive in this industry."
"I can definitely leverage the customers within the channels of distribution that we intend to reach with our food packaging line," says James. "Many of them distribute coffee products. I also see an opportunity for snack-food packaging, which requires metalized lamination. This packaging can also be applied to health products such as antibacterial cloths. The possibilities are endless! Let's try to make this work."
"Thank you, both," you say. "Would you get me the same type of information you gave me for the expansion project so that I can compute the cash flows?"
James laughs and says, "We anticipated this question!" Luke and I were just putting our information in an e-mail to you. You should have it by the time you get back to your office."
"Thanks so much!" you say. "I knew I could count on you."
Back in your office, the promised e-mail is in your Inbox. Now you can compute the cash flows given the following information:
- Initial investment outlay of $20 million for equipment only
- Project and equipment life: 5 years
- Sales projected tobe $12 million per year for 5 years.
- Assume gross margin of 50% (exclusive of depreciation)
- Depreciation: Straight-line for tax purposes
- Selling, general, and administrative expenses: 10% of sales
- Tax rate: 35%
As I started wondering if this coffee packaging project will maximize the firm's value I said to myself, I'll compute the NPV and see what it looks like and I will use a weighted average cost of capital (WACC) of 5% as reflected in the attached Week 5 NPV IRR.