Question
In: Finance
Smith Machining Corp. is a small business considering investing in one of 2 new product production...
Smith Machining Corp. is a small business considering investing in one of 2 new product production lines. However, they can only afford to do one of the projects. The development and implementation of either project will take a year and the initial cash outlay will be $1,500,000 if they take a traditional bank loan at 10%. If they pursue a Small Business Association (SBA) guaranteed loan through their bank, the rate on the loan will be 7% however, they will need to pay an up-front fee of 10% of the net proceeds of their loan, which can be added to the loan. The projects have the following projected net cash flows:
|
Year |
Project A |
Project B |
|
1 |
$ 250,000 |
$ 100,000 |
|
2 |
$ 250,000 |
$ 100,000 |
|
3 |
$ 250,000 |
$ 100,000 |
|
4 |
$ 500,000 |
$ 100,000 |
|
5 |
$ 500,000 |
$ 100,000 |
|
6 |
$ 250,000 |
$ 400,000 |
|
7 |
$ 100,000 |
$ 750,000 |
|
8 |
$ 50,000 |
$ 750,000 |
|
9 |
$ 50,000 |
$ 1,000,000 |
- Calculate and show the NPV of each project at the 10% rate
- Calculate and show the NPV of each project at the 7% SBA loan rate
- Which project would you choose, A or B and why?
- Does the SBA loan improve the result and would you recommend getting the SBA loan even with the added 10% cost? Why or why not?
Solutions
Expert Solution
| case 1 | WACC | 10% | ||
| Year | A | PV | B | PV |
| 0 | -1500000 | -1500000 | -1500000 | -1500000 |
| 1 | 250000 | 227272.7 | 100000 | 90909.09091 |
| 2 | 250000 | 206611.6 | 100000 | 82644.6281 |
| 3 | 250000 | 187828.7 | 100000 | 75131.48009 |
| 4 | 500000 | 341506.7 | 100000 | 68301.34554 |
| 5 | 500000 | 310460.7 | 100000 | 62092.13231 |
| 6 | 250000 | 141118.5 | 400000 | 225789.572 |
| 7 | 100000 | 51315.81 | 750000 | 384868.5887 |
| 8 | 50000 | 23325.37 | 750000 | 349880.5352 |
| 9 | 50000 | 21204.88 | 1000000 | 424097.6184 |
| NPV | 10644.93 | 263714.9912 |
| case 2 | WACC | 7% | ||
| Year | A | PV | B | PV |
| 0 | -1350000 | -1350000 | -1350000 | -1350000 |
| 1 | 250000 | 233644.9 | 100000 | 93457.94 |
| 2 | 250000 | 218359.7 | 100000 | 87343.87 |
| 3 | 250000 | 204074.5 | 100000 | 81629.79 |
| 4 | 500000 | 381447.6 | 100000 | 76289.52 |
| 5 | 500000 | 356493.1 | 100000 | 71298.62 |
| 6 | 250000 | 166585.6 | 400000 | 266536.9 |
| 7 | 100000 | 62274.97 | 750000 | 467062.3 |
| 8 | 50000 | 29100.46 | 750000 | 436506.8 |
| 9 | 50000 | 27196.69 | 1000000 | 543933.7 |
| NPV | 329177.4 | 774059.5 |
From both the cases it is evident that project B is more profitable than A.
SBA loan improves result of the NPA. Thus it is recommended to take the SBA loan
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