Reference no: EM132357401

Assignment -

You will use the following case study for this assignment: Kunz, D., & Dow, B., III. (2010). Cape Chemical: Capital budgeting issues. Journal of the International Academy for Case Studies, 16(5), 133-137.

Case Summary: This case is primarily a capital budgeting expansion project for the company, Cape Chemical, which has done very well in the past in terms of sales and profits growth, and now needs to expand. Furthermore, the sudden withdrawal of one key competitor from the region has opened the opportunity for Cape Chemical to increase its market share. Unfortunately, the company was already operating at its maximum. So, the company needs to expand its work force and storage capacity and acquire more equipment. However, the company has no set process for capital expenditure evaluation in place. The company is unsure whether it should buy used or new equipment. Although the used equipment costs significantly less, it has an economic life of just three years, while the new equipment will last seven years.

Your task is to conduct a cash flow analysis for each alternative and provide recommendations to Cape Chemical. This case study has two sections; the first part looks at the weighted average cost of capital (WACC), and the second extends to capital budgeting. Please answer only questions 1-3.

REQUIREMENTS - Assume the role of a consultant, and assist Clarkson to answer the following questions.

1) Calculate Cape Chemical's weighted average cost of capital (WACC). Note: round to the nearest whole number. Discuss the theory used by Clarkson to determine Cape Chemical's optimum target capital structure (30% debt and 70% equity).

2) Since the used equipment will be financed with internal capital and the new equipment with a bank loan, should the same discount rate be used to evaluate each alternative? Explain.

3) Explain why an accurate WACC is important to a firm's long-term success.

4) Evaluate the strengths and weaknesses of the Cash Payback Period, Discounted Cash Payback Period, NPV, IRR and MIRR capital expenditure budgeting methods. Prepare a recommendation for Stewart regarding the capital budgeting method or methods to use in evaluating the expansion alternatives. Support your answer.

5) Calculate the Cash Payback Period, Discounted Cash Payback Period, NPV, IRR and MIRR for each alternative. For these calculations, assume a WACC of 15%. Based strictly on the results of these methods, should either option be selected? Why? Solution requires preparation of a spreadsheet.

6) Stewart is concerned that the projected annual sales growth rate of 15% for incremental blended material may be optimistic. Recalculate the Cash Payback Period, Discounted Cash Payback Period, NPV, IRR and MIRR for each alternative assuming the annual sales growth rates of 10% and 5%. Assume a WACC of 15%. Does the change in growth rate alter the recommendation made in question 5? Solution requires preparation of spreadsheets. Explain.

7) The projected cash flow benefits of both projects did not include the effects of inflation. Future cash flows were determined using a constant selling price and operating costs (real cash flows). The cash flows were then discounted using a WACC that included the impact of inflation (nominal WACC). Discuss the problem with using real cash flows and a nominal WACC when calculating a project's Discounted Payback Period, NPV, IRR and MIRR.

8) What other issues should Stewart and Clarkson considered before a final decision regarding the expansion alternatives is made?

Attachment:- Case Study.rar