Case

Fruit-To-Go (FTG) processes fruit for shipping overseas.

FTG commissioned a study to look into the feasibility of changing the packaging of the fruit from cans to sealed bags. The Consultant charged $45000 for the report.

The report concluded that the new packaging will increase sales and reduce some operating costs.

The new packaging machinery will cost $1100000. The new machine is expected to last 5 years. The Taxation Office advise the life of the machine, for tax purposes, is 4 years.

The old canning machinery was purchased 2 years ago for $800000 and was being depreciated at $200000 and will be for the next 2 years. The old machine could be sold today for $130000. In 5 years it will be worth nothing.

Installing the new machine will require staff training (a tax deductible expense) of $35000 before production can commence. Due to the lower cost of the bags Inventory required will be reduced by $100000 for the life of the project.

The new sales of bagged fruit is expected to be $750000 in Year 1 rising by 20% for 1 year then 10% for the rest of the life of the project. Variable Costs associated with the new packaged fruit are 40% of sales.

Canned fruit production will be discontinued. Sales of canned fruit were static at $400000 with variable costs of $200000 (50% of Sales).

The new equipment is very hi-tech. Maintenance costs are expected to be higher at $40000 per year. Maintenance costs on the old machine were $30000 per year.

The lighter packaging will reduce annual freight cost significantly from $250000 to $140000 per year.

Fixed costs are expected to remain at $450000 per year.

At the end of the project the new machinery can be sold for $350000.

Notes:

FTG will borrow the full Year 0 funds using a secured five-year interest-only loan at an interest rate of 10% per annum to finance the new equipment.

The company tax rate is 30%.

The required rate of return is 12.5%.

Requirement:

You are required to answer and to conduct a capital budgeting analysis of the company. You must determine:

1. The cash flows at the start

2. The cash flows over the life

3. The cash flows at the end

4. The appropriate discount rate

5. The NPV of the project

6. The IRR of the project

7. The PI of the project

8. The payback of the project

9. A brief recommendation

10. Please give short explanation on how to make investing decision. (about 500 words)