Question

AGOURA MANUFACTURING MINI-CASE

Agoura Manufacturing has announced the introduction of a new product. They forecast product- specific sales demand to last five years. Then because this product is somewhat of a fad, they will terminate the project. Manufacturing of the product will require the acquisition of an existing facility and purchase and installation of some new equipment. The following information describes the new project:

Capital Investment requirement:

Cost of new plant and equipment:      $13,750,000 Shipping and installation costs:                          $   465,000

Working Capital requirements:

An initial working-capital requirement of $350,000 will accompany the start of production. After that, total investment in net working capital during each year will be equal to 16 percent of the dollar value of sales for that year. Therefore, the working capital investment required will increase during years 1 through 3, decrease in year 4, and finally, all working capital is converted to cash at the termination of the project at the end of year 5.

Sales Forecast:

Year	Units Sold
1	75,000
2	115,000
3	195,000
4	75,000
5	45,000

Sales price per unit: $275/unit in years 1–4, $180/unit in year 5 Variable cost per unit: $215/unit

Annual fixed costs: $675,000

Other Assumptions:

Agoura Manufacturing uses the simplified straight-line depreciation method over useful life. The plant and equipment will have no salvage value after five years. Agoura Manufacturing pays taxes at a 34% marginal rate. Their cost of capital is 17%, and this project offers a similar risk profile to the company’s overall operations.

1. Calculate Agoura’s initial outlay. Calculate the terminal cash flow.

Answer 1

1	a	cost of New plant and Equipment	(13,750,000)
	b	Shipping and installation cost	(465,000)
	c	Capital cost	(14,215,000)	a+b
	d	Working capital	(350,000)
	e	Initial cash outlay	(14,565,000)	c+e
2		Cash inflow on year 5	3,300,000

Workings:

	T0	T1	T2	T3	T4	T5
Initial cash outlay on machinery	(14,215,000)
Sales units		75,000	115,000	195,000	75,000	45,000
Sales price		275	275	275	275	180
Sales value		20,625,000	31,625,000	53,625,000	20,625,000	8,100,000
Cost @ 215/unit		(16,125,000)	(24,725,000)	(41,925,000)	(16,125,000)	(9,675,000)
Annual fixed cost		(675,000)	(675,000)	(675,000)	(675,000)	(675,000)
Depreciation (Note 1)		(2,843,000)	(2,843,000)	(2,843,000)	(2,843,000)	(2,843,000)
Net income		982,000	3,382,000	8,182,000	982,000	(5,093,000)
tax @ 34%		(333,880)	(1,149,880)	(2,781,880)	(333,880)	1,731,620
Net income after tax		648,120	2,232,120	5,400,120	648,120	(3,361,380)
Add back non cash depreciation		2,843,000	2,843,000	2,843,000	2,843,000	2,843,000
Net cash flow from operations		3,491,120	5,075,120	8,243,120	3,491,120	(518,380)
Incremental working capital (note 2)	(350,000)	(2,950,000)	(1,760,000)	(3,520,000)	5,280,000	3,300,000
Total cash flow	(14,565,000)	541,120	3,315,120	4,723,120	8,771,120	2,781,620
PV factor @ 17% (1/1.17^n)	1	1	1	1	1	0
Discounted cash flow	(14,565,000)	462,496	2,421,740	2,948,977	4,680,709	1,268,728
NPV	(2,782,351)
Note 1
Capital cost (Answer 1 C)	(14,215,000)
No of years	5
Depreciation (Capital cost/No of years)	(2,843,000)
Note 2	T5 = (T0 to T4). T0 to T5 should be 0
Working capital (16% of sales value from T1)	(350,000)	(3,300,000)	(5,060,000)	(8,580,000)	(3,300,000)	(1,296,000)
Incremental T - T-1 (Use above)		(2,950,000)	(1,760,000)	(3,520,000)	5,280,000	3,300,000
Formula for above incremental		3300000-350000	5060000-3300000'	8580000-5060000	3300000-8580000	Return of entire Working capital