Annual sales of Laurentian Bakeries had match plant capacity of 10. 9 million frozen pizzas per year. If Laurentian Bakeries would consider their opportunity in US the arrangement would provide them with optimistic scenario that show their sales increase by 5. 3 million extra pizzas. In the 1996 the increase would be 2.
2 million, than 1. 8 million in 1997, and 1. 3 million in 1998, and after that increase would be 5. 3 million per year to 2005. So the total production for the 1996 would be 13.
1 million, in 1997 14. 9 million, and every year after 1997 the total production would be 16. million.The pessimistic scenario would show their sales increase by 2.
65 million extra pizzas. This is 50% of the optimistic amount because their agreement guarantees them only 50% sale in US. In the pessimistic scenario 1996 the increase would be 1. 1 million, than 0. 9 million in 1997, and 0. 65 million in 1998, and after that increase would be 2.
65 million per year. So the total production for the 1996 would be 12 million, in 1997 12. 9 million, and every year after 1997 the total production would be 13. 55 million. The price per pizzas, which is at $1. 0, will increase each year by inflation rate, which we assumed it would be 4%.
The operating margin is 15% of the unite price, and get additional profits we have to multiply operating margin with additional unit sales. With additional sales, project would provide reduction in production costs, by installing new line, in two ways: efficiency savings and other savings. The other savings resulting from new line would be 138,000 for 1996 and it would increase each year at rate of inflation. The efficiency gains per unit would reduce plant-wide unit cost by 0. 19, but only 70% or 0. 0133 would be realized in first year.
In pessimistic scenario the efficiency gains would reduce plant-wide unit cost by 50% of 0. 019, which is 0. 0095, and only 70% or 0. 00655 would be realized in first year. To get efficiency saving we have to multiply efficiency gains with total production. Adding additional profits, efficiency savings and other saving will give as the total additional profits.
To get taxes payable from total additional profits subtract the CCA and multiply that by tax rate, which is 38. 50%.The after-tax cash flow is total additional profits minus taxes payable, and to get net cash flow we have to subtract change in working capital from after-tax cash flow. The change in working capital is amount that we will need because of the new production line.
It is calculated by multiplying additional unit sales with unit price and 38 days, which are sum of inventory and A/R minus A/P and minus 2 days from average inventory age, and divide by 365 days. The total change in working capital it will be added back in the last year of proposal. The capital expenditure of 5. million is taken in 1995 and won’t be taken in consideration to get net cash flow.
After getting net cash flow we can calculate the payback period, NPV and IRR by taking in consideration both the hurdle rate of 18% and WACC of 10. 37%, and initial investment of 5. 2 million. The payback period for optimistic scenario is 5. 03 years, and for pessimistic is 7.
44 years. The NPV for optimistic with hurdle rate is 121,637, and with WACC rate is approximately 2. 5 million. The pessimistic NPV is approximately (1. 92 million) for hurdle rate and (0. 5 million) for WACC rate.
The IRR for optimistic is 18. 51% and for pessimistic is 8. 45%.
