Question

Mini Cases

Shrieves Casting Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by Sidney Johnson, a recently graduated MBA. The production line would be set up in unused space in Shrieves’s 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 Shrieves has obtained a special tax ruling that places the equipment in the MACRS 3-year class. 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 4 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 both expected to increase by 3 percent 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 percent of sales revenues. The firm’s tax rate is 40 percent, and its overall weighted average cost of capital is 10 percent.

e. Estimate the required net operating working capital NOWC for each year and the cash flow due to changes in NOWC.

f. Calculate the after-tax salvage cash flow.

g. Calculate the project cash flows for each year. Based on these cash flows and the average project cost of capital, what are the project’s NPV, IRR, MIRR, PI and payback and discounted payback? Do these indicators suggest that the project should be undertaken?

Answer 1

e)

above image shows formulas

f)

salvage value before tax = 25000

book value = 0

salvage value after tax = 25000(1 - 0.4)= $15,000

g)

formulas for above answers are as follows: