Question

The Austin Saddle Company Expansion The Austin Saddle Company Expansion (ASC) is considering expanding its tannery facilities, increasing its production capacity by 20 percent. The ASC brought in the marketing, production management, procurement, capital investment, and accounting department to formulate estimates of the initial cost of the expansion, as well as future cash flow that can be used to evaluate this expansion. The procurement and capital management teams expect that the expansion will require $10 million initially, with the first year’s operating cash flow of $2 million. The operating cash flows are expected to grow at a rate of 5 percent each year for 3 years, but then to slow to a 3 percent growth thereafter. The ACS has a cost of capital of 8 percent, and the expansion project is expected to have risk similar to ACS’s typical project.

A. Should ACS expand? Explain your reasoning.

B. If ACS’s cost of capital increased to 10 percent, would your recommendation change?

C. At what cost of capital, if any, would your recommendation change? Indicate your decision on a net present value profile of this investment decision.

D. If the growth rate were to be 3 percent, ad infinitum, would your decision change? Explain

Present Calculation With EXCEL

Answer 1