Question

Alberta Pasta is considering producing a new type of pasta. The required equipment has a constant capital cost allowance over its 3-year life with a zero salvage value. No new working capital would be required. Revenues and cash operating costs are expected to be constant over the project’s 3-year life. However, this project would compete with other Alberta Pasta products and would reduce the company’s pre-tax annual cash flows. What is the project’s NPV? WACC 10.0% Pre-tax cash flow reduction in other products (cannibalization) $15,000 Investment cost $65,000 Annual capital cost of allowance (assume constant capital cost allowance for ease of computation) $31,000 Annual sales revenues $80,000 Annual cash operating costs $25,000 Tax rate 25.0%

a) $93,879
b) $37,750
c) $29,325
d) $28,879

Answer 1

To calculate the NPV for Alberta Pasta's new type of pasta project, annual cash flows are adjusted for annual operating and cannibalization costs, depreciation, and taxes before discounting them to their present value using the WACC rate. The total present value of these cash flows over the 3-year life span minus the initial investment would give us the NPV.

Step-by-step explanation:

To find Alberta Pasta's projected Net Present Value (NPV), we need to account for the initial investment, the annual revenue, cash operating costs, cannibalization costs, depreciation (capital cost allowance), and taxes. We also need to apply the discount rate, which is the Weighted Average Cost of Capital (WACC), to future cash flows.

Here's the calculation:

• Annual Revenue: $80,000
• Annual Operating Costs: $25,000
• Depreciation (Capital Cost Allowance): $31,000
• Cannibalization Costs: $15,000
• Tax Rate: 25%
• WACC (Discount Rate): 10%

We calculate the cash flows before tax by subtracting the annual operating costs and cannibalization costs from the annual revenue. Then, we subtract the depreciation to find the taxable income. The tax is then calculated and subtracted from the pre-tax cash flows to get the after-tax cash flows. These cash flows are then discounted using the WACC to calculate the present value. Sum up the present values for the three years, and subtract the initial investment to get the NPV.

Without the specific cash flows, we cannot provide the exact NPV from the available options (a, b, c, d).