Question

Anthony Bucker, the CEO of Bucker’s, Inc. is currently reviewing a proposal to purchase a set of equipment that would add a unique candle holder, what is known as “Angel Chimes”, to the company’s production line. Bucker’s, Inc. has been manufacturing galvanize-coated buckets, pans, watering cans, flower pots & vases, and various sizes of trash-cans for home and garden use for the past 25 years. With this new addition to its product line, Bucker’s, Inc. would penetrate further into decorative home-goods markets.

Angel Chimes is a unique, brass-made candle-holder. It was originally introduced in Sweden and has become a popular Christmas product in the entire Europe. It makes a delightful Christmas gift that could be enjoyed by all ages as part of joyous memories.   The heat from the four candles spins a carousel of angels causing them to lightly tap the bells generating charming tinkling sounds. Celine Barber, the marketing manager at Bucker’s, believes that Angel Chimes could be sold for $6 each and a volume of 10,000 units could be reached within its first year of inception.

The semi-automated machine to be used in the production of Angel Chimes can be purchased for $170,000, but it requires $30,000 additional spending on delivery and installation. The cost of the material is estimated to be 40% while labor and overhead expenses will run around 12% of the sales price. The annual sales figure is estimated to grow at 5% per year. The equipment is expected to worn-out totally in ten years and can be sold for $20,000 only. For tax purposes, the equipment qualifies for Five-Year MACRS property (the appropriate percentages are provided in the following table):

MACRS Recovery Allowance Percentages for Five-Year Property
Ownership Year	Recovery Percentage (%)
1	20
2	32
3	19
4	12
5	11
6	6

Anthony finds the Angel Chimes project quite attractive at first glance; however, he is cautious in implementing any capital budgeting proposal that could be detrimental to his company and its common stocks. As such, he asks you to run an assessment of Angel Chimes project via most reliable decision criteria, i.e., NPV and IRR. Currently Bucker’s WACC to apply to an average risk project is 14% and the company is subject to a marginal tax rate of 34%.

(a) Compute the NPV and IRR of the above proposal assuming a 34% tax rate. What is your recommendation to Mr. Bucker?

Anthony Bucker, while a college dropout (mainly due to financial challenges his parents and himself had to face during the first two semesters of his college years) proved to be a wise and successful businessman during his 25 years of practice in the industry. With his exceptional vision on decorative home-goods design and production, Anthony was quick to recognize that this new equipment could be utilized to introduce various additional and equally attractive tinkling candle-holders with different concepts and figures. This, however, would require the acquisition of an additional pressing machine for $30,000 to produce the new figures and characters. This piece of equipment, if purchased, will also qualify for Five-Year MACRS property and will be sold for $5,000 at the end of 10 years.

Anthony doesn’t anticipate any cannibalization affect since these additional candle-holders will be in demand all year around while Angel Chimes are proven to be a unique Christmas-season item.   Celine’s analyses in this regard indicates that Bucker’s Inc. should be able to sell 7,500 units of these additional candle holders in the first year at $5 each. For the following years, the sales are estimated to grow at 5% per year. The cost of the material will be 40% while labor and overhead expenses will be negligible since the additional production can be accomplished without any over-time expectations from the workers.

b.) Compute the NPV and IRR of the Angle Chimes proposal together with this additional modification/investment. What is your recommendation to Mr. Bucker when two compatible proposals are considered/evaluated together?

Answer 1

Solution is as under:

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