Question

Shrieves Casting Company is considering adding a new line to its product mix, and the company hires you, a recently business school graduate, to conduct capital budgeting analysis. The production line would be set up in unused space in Shrieves' main plant. The machinery’s invoice price would be approximately $200,000; another $10,000 in shipping charges would be required; and it would cost an additional $30,000 to install the equipment. The machinery has an economic life of 4 years, and would be a class 8 with a 20% CCA rate. The machinery is expected to have a salvage value of $25,000 after 4 years of use.                                                                                                                                                                                                              

The new line would generate incremental sales of 1,250 units per year for four years at an incremental cost of $100 per unit in the first year, excluding depreciation. Each unit can be sold for $200 in the first year. The sales price and cost are expected to increase by 3% per year due to inflation. Further, to handle the new line, the firm’s net operating working capital would have to increase by an amount equal to 12% of sales revenues. The firm’s tax rate is 28%, and its overall weighted average cost of capital is 10 percent. Suppose the firm had spent $100,000 last year to rehabilitate the production line site.Assume that the plant space could be leased out to another firm at $25,000 a year.     

What is the project's after-tax NPV? Should the project proceed? Prepare a report including capital budgeting ( IRR, NPV, MIRR , risk analysis and comments. ( I appreciate it if you give me the detail of calculating, I have a problem in calculating that. )

Answer 1

The project is high-risk project. It is a measure of the stand-alone risk of the project.

	YEAR 0	YEAR 1	YEAR 2	YEAR 3	YEAR 4
Investment outlay: long term assets	(240,000)
Operating cash flows		106,680	120,450	93,968	88,675
CF due to investment in NWC	(30,000)	(900)	(927)	(955)	32,782
Salvage cash flows					15,000
Net cash flows	(270,000)	105,780	119,523	93,013	136,457

NPV = $88,026

The project can be impemented since NPV is positive.

IRR = 23.9 %

PV of inflows $358,026 TV of inflows $524,186

Calculation of MIRR

	YEAR 0	YEAR 1	YEAR 2	YEAR 3	YEAR 4
Net cash flows	(270,000)	105,780	119,523	93,013	136,457
					102,314
					144,623
					140,793
PV =	($270,000)			TV =	$524,186

To find MIRR, we could now find the discount rate that equates the PV and TV. But it is easier to use the MIRR

function. MIRR = 18%

Calculation of Payback

	YEAR 0	YEAR 1	YEAR 2	YEAR 3	YESR 4
Cash flow	(270,000)	105,780	119,523	93,013	136,457
Cumulative cash flow for payback	(270,000)	(164,220)	(44,697)	48,316	184,772

Payback = 2.5