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, risk analysis and comments.

Answer 1

			New line	1250	unit/year
Machinery			Year	1	2	3	4
Invoice price	200000		SP	200	206	212	219
Shipping	10000		Cost	100	103	106	109
Installation	30000
Net price	240000		Revenue	250000	257500	265225	273182
Dep	48000		Cost	125000	128750	132613	136591
Salvage	25000		WC	30000	30900	31827	32782
			Opportunity Cost	25000	25000	25000	25000
Tax	28%		Depreciation-tax savings	13440	13440	13440	13440
WACC	10%		Salvage				25000
			CI	83440	86290	89226	117249
			PVIF	0.91	0.83	0.75	0.68
Answer-			PV of CI	75855	71314	67036	80083
PVCO	-240000
PVCI	294288
NPV	54288