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.     

Prepare a report including risk analysis, and comments. ( I appreciate it if you give me the detail of calculating and Also RISK Analysis, I have a problem in calculating that. )

Answer 1

SInce at the end of economic life UCC is ) so after 3 year, remaining UCC is taken as depreciation for 4th year. UCC for 1st year is purchase cost + related expense- salvage value. I forgot to take into account salvage value of machinery during calculation, so i added it at the end. Salvage value & working capital are taken as inflow for 5th year because they can be recovered only after closure of business or in this case after the end of expected economic life of machinery.