Let's break down the step-by-step solution to **evaluate the juice production project** for Holiday Group, Inc. We'll focus on calculating the **project's Net Present Value (NPV)**, which is the standard approach for capital budgeting decisions. --- # **Step 1: Identify Relevant Cash Flows** ### **Initial Investment (Year )** - **Cost of equipment:** CAD 2,700,000 (from the Investment Plan) - **Working capital:** CAD 270,000 (from the Investment Plan) - **Research cost (Phase 3):** CAD 40,000 (from the case, for pilot study) - *Note*: This is a sunk cost (already spent), so it is **not included** in NPV calculation. ### **Ongoing Cash Flows (Years 1-5)** #### **Revenue** - **Unit price** and **production quantity** per year are given. - Both unit price and cost of materials increase by 5% inflation each year. #### **Costs** - **Cost of materials** per case (inflated by 5% each year) - **Labour costs** (increase by 15% each year) - **Overhead** (increase by 15% each year) - **Working capital**: Only the change (increment) each year affects cash flow. - **Interest expense:** Not included in project cash flows (financing cash flows are excluded from NPV). #### **Tax Depreciation** - **CCA rate:** 20% per year (half-year rule applies in Year 1). - **Corporate tax rate:** 30%, with a 1-year lag. #### **Terminal Year (Year 5)** - **Working capital released:** Recovered at end of Year 5. - **Salvage value:** $. --- # **Step 2: Calculate Yearly Revenues and Costs (Inflation Adjusted)** ### **Revenue Calculation** For each year \( t \): - **Unit Price (inflated):** \( \$5.00 \times 1.05^{t-1} \) - **Production Quantity:** As given in the table. #### **Example for Year 1:** - Unit Price = \$5.00 - Quantity = 675,000 cases - Revenue = \$5.00 × 675,000 = \$3,375,000 = CAD 3,375 (in '000s) #### **For Year 2:** - Unit Price = \$5.00 × 1.05 = \$5.25 - Quantity = 810,000 - Revenue = \$5.25 × 810,000 = \$4,252,500 = CAD 4,253 (in '000s) *Continue this for each year, increasing unit price by 5% each year.* --- ### **Material Cost Calculation** - **Material Cost per Case (inflated):** \( \$1.00 \times 1.05^{t-1} \) - **Total Material Cost:** Material cost per case × production quantity --- ### **Labour and Overhead (Increase by 15% per year)** - Start with given Year 1 amounts. - Increase by 15% per year. #### **Labour:** - Year 2: \( \$1,013 \times 1.15 = \$1,165 \) (in '000s) - Year 3: \( \$1,165 \times 1.15 = \$1,340 \) (in '000s) - ... (and so on, or use the table if already inflated) #### **Overhead:** - Year 2: \( \$405 \times 1.15 = \$466 \) (in '000s) - Year 3: \( \$466 \times 1.15 = \$536 \) (in '000s) - ... (and so on) --- # **Step 3: Calculate Depreciation (CCA) Schedule** - **Year UCC:** \$2,700,000 - **Year 1**: Half-year rule → CCA base = \$2,700,000 × 50% = \$1,350,000 - **CCA claimed Year 1:** \$1,350,000 × 20% = \$270,000 - **UCC end Year 1:** \$2,700,000 - \$270,000 = \$2,430,000 - **Year 2:** CCA = \$2,430,000 × 20% = \$486,000 - **UCC end Year 2:** \$2,430,000 - \$486,000 = \$1,944,000 - ... (continue for all years) --- # **Step 4: Calculate Taxable Income and Taxes** **Taxable Profits = (Revenue - All Operating Costs - CCA Deduction)** - Calculate for each year. - Multiply taxable profit by 30% for taxes (paid 1 year later). --- # **Step 5: Calculate Incremental Working Capital Changes** - Yearly working capital = as per table (inflated by 5% per year). - **Cash flow impact:** Only the **change** in working capital each year is a cash flow (increase is cash outflow, decrease is cash inflow). - In Year 5, **all working capital is released**. --- # **Step 6: Calculate Net Cash Flow for Each Year** **Net Cash Flow = After-tax Operating Cash Flow + Tax Shield from CCA - Change in Working Capital** --- # **Step 7: Discount Cash Flows to Present Value** - Use **20% as the discount rate** (after-tax WACC). - NPV = Sum of Present Value of all net cash flows, subtracting initial investment. --- # **Step 8: Decision** - If NPV > : **Accept the project** - If NPV < : **Reject the project** --- # **Sample Calculation for Year 1 (in '000s, for illustration)** ### **Revenue:** - Unit Price = \$5.00 - Quantity = 675 - Revenue = \$5.00 × 675 = \$3,375 ### **Costs:** - Material = \$1.00 × 675 = \$675 - Labour = \$1,013 - Overhead = \$405 ### **Operating Profit:** - EBIT = Revenue - Material - Labour - Overhead - EBIT = \$3,375 - \$675 - \$1,013 - \$405 = \$1,282 ### **CCA Deduction:** - CCA = \$270 ### **Taxable Profit:** - Taxable Income = EBIT - CCA = \$1,282 - \$270 = \$1,012 ### **Tax (paid in Year 2):** - Tax = \$1,012 × 30% = \$304 ### **Net Cash Flow Year 1:** - EBIT = \$1,282 - Add back CCA (non-cash): +\$270 - Less tax (paid next year, so ignore for now in Year 1 cash flow) - Less increase in WC: \$338 - \$270 = \$68 (outflow) - **Net Cash Flow = \$1,282 + \$270 - \$68 = \$1,484** (before tax payment) ### **Year 2:** - Revenue, costs, etc., **increase by inflation** - Taxes paid in Year 2 for Year 1's taxable profit, etc. --- # **Final Step: Sum All Discounted Cash Flows** - Discount each year’s net cash flow using 20% WACC. - Subtract initial investment (equipment + initial working capital). --- # **Summary Table Example (Year 1 only, in '000 CAD):** | Year | Revenue | Material | Labour | Overhead | EBIT | CCA | Taxable | Tax (paid next year) | Net Cash Flow | PV Factor (20%) | PV | |------|---------|----------|--------|----------|------|-----|---------|---------------------|---------------|-----------------|-------| | | | | | | | | | | -2,700 (equip) -270 (WC) | 1.00 | -2,970| | 1 | 3,375 | 675 | 1,013 | 405 |1,282 |270 | 1,012 | 304 | 1,484 | .833 |1,236 | | ... | | | | | | | | | | | | --- ## **You can repeat these steps for each year, and sum the PVs for NPV.** --- ## **If you need a full Excel model or more detailed calculations for all years, let me know!** --- ## **Final Answer** (Structure): > **NPV = [Sum of discounted cash flows for years 1-5, plus recovery of WC in year 5] - [Initial investment + initial working capital]** > > **If NPV > , accept the project. If NPV < , reject the project.** --- **Let me know if you want all years calculated out, or if you want the Excel formulas for each step!**