Indian River Citrus Company Case Questions

INDIAN RIVER CITRUS COMPANY CASE
DISCUSSION QUESTIONS
Question 1
Define the term "incremental cash flow." Since the project will be financed in part by
debt, should the cash flow statement include interest expenses? Explain.
Question 2
Should the $100,000 that was spent to rehabilitate the plant be included in the analysis?
Question 3
Suppose another citrus producer had expressed an interest in leasing the lite orange
juice production site for $25,000 a year. If this were true (in fact, it was not), how would
that information be incorporated into the analysis?
Question 4
What is Indian River's Year 0 net investment outlay on this project? What is the expected
non-operating cash flow when the project is terminated at Year 4?
Question 5
Estimate the project's operating cash flows. What are the project's NPV, IRR, modified
IRR (MIRR), and payback? Should the project be undertaken?
Question 6
Now suppose the project had involved replacement rather than expansion of existing
facilities. Describe briefly how the analysis would have to be changed to deal with a
replacement project.
Question 7
Assume that inflation is expected to average 5 percent per year over the next four years.
a. Does it appear that the project's cash flow estimates are real or nominal? That is, are
the cash flows stated in constant (current year) dollars, or has inflation been built into
the cash flow estimates? (Hint: Nominal cash flows include the effects of inflation, but
real cash flows do not.)
b. Is the 10 percent cost of capital a nominal or a real rate?
c. Is the current NPV biased, and, if so, in what direction?
Question 8
Now assume that the sales price will increase by the 5 percent inflation rate beginning
after Year 0. However, assume that cash operating costs will increase by only 2 percent
annually from the initial cost estimate, because over half of the costs are fixed by longterm contracts. For simplicity, assume that no other cash flows (net externality costs,
salvage value, or net working capital) are affected by inflation. What are the project's
NPV, IRR, MIRR, and payback now that inflation has been taken into account? (Hint: The
Year 1 cash flows, as well as succeeding cash flows, must be adjusted for inflation
because the original estimates are in Year 0 dollars.)
Question 9
The second capital budgeting decision which Lili and Brent were asked to analyze
involves choosing between two mutually exclusive projects, S and L, whose cash flows
are set forth below:
-- Expected Net Cash Flow -Year Project S
Project L
0
($100,000)
($100,000)
1
60,000
33,500
2
60,000
33,500
3
33,500
4
33,500
Both of these projects are in Indian River's main line of business, orange
juice, and the investment, which is chosen, is expected to be repeated indefinitely into
the future. Also, each project is of average risk, hence each is assigned the 10 percent
corporate cost of capital.
a. What is each project's single-cycle NPV? Now apply the replacement chain
approach and then repeat the analysis using the equivalent annual annuity
approach. Which project should be chosen, S or L? Why?
b. Now assume that the cost to replicate Project S in two years is estimated to be
$105,000 because of inflationary pressures. Similar investment cost increases will
occur for both projects in Year 4 and beyond. How would this affect the analysis?
Which project should be chosen under this assumption?
Question 10
The third project to be considered involves a fleet of delivery trucks with an engineering
life of three years (that is, each truck will be totally worn out after three years). However,
if the trucks were taken out of service, or "abandoned," prior to the end of three years,
they would have positive salvage values. Here are the estimated net cash flows for each
truck:
Initial Investment
End-of-Year Net
Year and Operating Cash Flow
Abandonment Cash Flow
0
($40,000)
$40,000
1
16,800
24,800
2
16,000
16,000
3
14,000
0
The relevant cost of capital is again 10 percent.
a. What would the NPV be if the trucks were operated for the full three years?
b. What if they were abandoned at the end of Year 2? What if they were abandoned at the
end of Year 1?
c. What is the economic life of the truck project?

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INDIAN RIVER CITRUS COMPANY CASE

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