Question

Choice 2 Capital Budgeting Decision Since LSUS corporation is producing at full capacity, Amanda has decided to have Han examine the feasibility of a new manufacturing plant. This expansion would represent a major capital outlay for the company. A preliminary analysis of the project has been conducted at a cost of $1.6 million. This analysis determined that the new plant will require an immediate outlay of $54 million and an additional outlay of $31 million in one year. The company has received a special tax dispensation that will allow the building and equipment to be depreciated on a 20-year MACRS schedule. For Property Maced in Service aner December 11, 1996 3-Year S-Year 7-Yeu 10 Year 15 Year 20-Year Because of the time necessary to build the new plant, no sales will be possible for the next year. Two years from now, the company will have partial-year sales of $17 million. Sales in the following four years will be $28 million, $37 million, 540 million, and $43 million. Because the new plant will be more efficient than LSUS corporation's current manufacturing facilities, variable costs are expected to be 65 percent of sales, and fixed costs will be $2.4 million per year. The new plant will also require net working capital amounting to 8 percent of sales for the next year. Han realizes that sales from the new plant will continue into the indefinite future. Because of this, he believes the cash flows after Year 5 will continue to grow at 2.5 percent indefinitely. The company's tax rate is 40 percent and the required return is 12 percent.

QUESTION 3

3) After the examine the three approaches, Amanda would like Han to analyze the financial viability of the new plant and calculate the profitability index, NPV, and IRR.

Answer 1

Capital Budgeting			$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn	$ in Mn
			Y0	Y1	Y2	Y3	Y4	Y5	Y6	Y7	Y8	Y9	Y10	Y11	Y12	Y13	Y14	Y15	Y16	Y17	Y18	Y19	Y20	Y21	Y22
Preliminary Analysis cost			-1.6
Project cost out lay			-54	-31
Working capital				-1	-2	-3	-3	-3	-4	-4	-4	-4	-4	-4	-4	-4	-4	-4	-5	-5	-5	-5	-5	-5
Revenue from Sales					17	28	37	40	43	44	45	46	47	49	50	51	52	54	55	56	58	59	61	62	64
Variable cost					11.1	18.2	24.1	26.0	28.0	28.6	29.4	30.1	30.9	31.6	32.4	33.2	34.1	34.9	35.8	36.7	37.6	38.5	39.5	40.5	41.5
Fixed cost					2.4	2.4	2.4	2.4	2.4	2.4	2.4	2.4	2.4	2.4	2.4	2.4	2.4	2.4	2.4	2.4	2.4	2.4	2.4	2.4	2.4
Margin					3.6	7.4	10.6	11.6	12.7	13.0	13.4	13.8	14.2	14.6	15.1	15.5	15.9	16.4	16.9	17.3	17.8	18.3	18.9	19.4	19.9
Depreciation					3.2	6.3	5.8	5.3	4.9	4.6	4.2	3.9	3.9	3.9	3.9	3.9	3.9	3.9	3.9	3.9
Tax					0.1	3.0	4.2	4.6	5.1	5.2	5.4	5.5	5.7	5.9	6.0	6.2	6.4	6.6	6.7	6.9	7.1	7.3	7.5	7.8	8.0
PAT					3.4	4.4	6.3	7.0	7.6	7.8	8.0	8.3	8.5	8.8	9.0	9.3	9.6	9.8	10.1	10.4	10.7	11.0	11.3	11.6	12.0
Cash Inflow	( PAT+ Depreciation)				6.7	10.7	12.1	12.3	12.5	12.4	12.3	12.2	12.4	12.6	12.9	13.2	13.4	13.7	14.0	14.3	10.7	11.0	11.3	11.6	12.0
Net Cash Flows			-55.60	-32.36	4.44	7.73	8.91	8.87	9.01	8.78	8.58	8.40	8.50	8.65	8.81	8.97	9.13	9.30	9.47	9.64	5.96	6.15	6.34	6.53	11.97
Percent Value cash Flows	12%		-55.60	-32.36	3.96	6.16	6.34	5.64	5.11	4.45	3.88	3.39	3.06	2.79	2.53	2.30	2.09	1.90	1.73	1.57	0.87	0.80	0.74	0.68	1.11
NPV			-26.85
IRR			7%

Payback Period			Y12 means with in 1o years the cash will be pay backed
Report in Brief
If Project cost of Capital is @ 12 % , this project is not Viable
IRR is 7%, Means if the cost of capital less then 7% is viable for this project