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Pistachio, Inc. is thinking of building a bakery to introduce French cookies, so-called macarons, to the Newark market. A preliminary marketing study, which cost $75,000 and which was completed last year, showed a significant demand for macarons in the Newark area. The bakery is expected to last for 25 years. Its initial cost is $175,000. This cost can be depreciated over 15 years using straight line depreciation. The salvage value of the equipment in the bakery after 15 years is $20,000 in real terms. After 15 years the bakery can be renovated. The cost of renovation will be $50,000 in real terms and can be depreciated (again using straight line depreciation) over the remaining 10 years of the bakery's life. The salvage value of the equipment after the remaining 10 years will be $10,000 in real terms. The land the bakery is built on could be rented out for $12,500 a year in real terms for 25 years.

The bakery will be able to produce 75,000 macarons a year. The price of a macaron is currently $1.55. It is expected to grow at a rate of 5% per year in real terms for the first 2 years, then at 2% per year in real terms for 4 years and finally stays the same in real terms thereafter for the remainder of the bakery's life. Pistachio, Inc. expects to be able to sell all the macarons that it can produce. The basic ingredients for a macaron currently (t = 0) cost $0.25. These costs are expected to grow by 1% in real terms through the lifetime of the project. The labor required to operate the bakery is expected to cost a total of $45,000 dollars in nominal terms in t = 1 and this is expected to increase at 4% in real terms thereafter. There is no working capital requirement. The rate of inflation is expected to be 3% per year for the remainder of the bakery's life. The firm's total tax rate including local taxes is 36 percent. Pistachio, Inc. expects to make substantial profits on its other products so that it can offset any losses on the bakery for tax purposes. Its opportunity cost of capital for projects of this type is 11% in nominal terms.

problems:

1. Construct two spreadsheets in EXCEL to find the NPV of the macarons project. One spreadsheet should be in nominal terms and one spreadsheet should be in real terms. The two spreadsheets should give the same value for the NPV. Should the firm build the bakery or not?

2. Do a sensitivity analysis by varying by plus and minus 10% the
a) initial labor cost (holding everything else constant)
b) initial cost per macaron (holding everything else constant)
c) quantity sold (holding everything else constant)
d) price per macaron (holding everything else constant)

Basic Finance, Finance

  • Category:- Basic Finance
  • Reference No.:- M927527

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