The Leventhal Baking Company is thinking of expanding its operations into a new line of pastries. The firm

| June 4, 2016

Question
The Leventhal Baking Company is thinking of expanding its operations into a new line of pastries. The firm expects to sell $350,000 of the new product in the first year and $500,000 each year thereafter. Direct costs including labor and materials will be 60% of sales. Indirect incremental costs are estimated at $40,000 a year. The project will require several new ovens that will cost a total of $500,000 and be depreciated straight line over five years. The current plant is underutilized, so space is available that cannot be otherwise sold or rented. The firm’s marginal tax rate is 35%, and its cost of capital is 12%. Assume revenue is collected immediately and inventory is bought and paid for every day, so no additional working capital is required.

a. Prepare a statement showing the incremental cash flows for this project over an 8-year period. (Structure as a new venture.)

b. Calculate the Payback Period, NPV, and PI.

c. Recommend either acceptance or rejection.

d. If the space to be used could otherwise be rented out for $30,000 a year, how would you put that fact into the calculation. Would the project be acceptable in that case?

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