Reference no: EM132867629

Question - Desert Camping Accessories (DCA) in Amman, Jordan specializes in making and selling desert safari and camping accessories. The company was started by Ahmad in 2012 and has been doing very well. In addition to Jordan, DCA sells a large percentage of its products in Saudi Arabia and other Arab gulf countries.

Most of the camping tools sold by DCA are made of aluminum. While customers appreciate the lightweight nature of the tools, some have expressed disappointment with their durability and toughness. Ahmad has been looking for a solution to this problem & enhance customer satisfaction.

Recently a Chinese company (CSEC) contacted Ahmad informing him about a new machine they have which would replace DCA's existing machine but has the added capability of coating the aluminum tools with a special compound making them more durable and powerful. CSEC shared a link with Ahmad and invited him to watch the machine in action. Ahmad called on his production engineer, Sami, and they watched the video together. They liked what they saw and decided to pursue the potential acquisition of the machine further.

Ahmad contacted CSEC and asked about the possibility of a live demonstration. CSEC welcomed the idea and informed Ahmad that they would be able to do that in their factory in Shanghai. CSEC offered to cover the demonstration costs, but DCA would have to absorb travel and accommodation expenses for travel to Shanghai.

Ahmad agreed and two weeks later he and Sami went to Shanghai and were impressed with what they saw. They decided that the machine would be very good for DCA but wanted to study its economic viability. The trip cost DCA a total of $8,600.

Ahmad talked to CSEC about the possibility of buying the machine and CSEC told him that the price, delivered to Aqaba Port, Jordan would be $290,000. DCA would have to pay any clearance and handling costs in the port. Ahmad contacted a technical company in Amman and asked them about the costs of installing and setting up the machine in his premises. A couple of days later, the technical company told Ahmad that they will take care of everything including clearance at the port, handling and installation for a total of $12,500.

Ahmad called a meeting of all his managers and shared with them the idea of buying the new machine. Nadia, the marketing manager decided she needed to assess whether offering tools with the coating would stimulate a change in demand. Nadia called ASRA (All-Sight Research and Analytic), a marketing research firm and told them about her needs. She shared with ASRA a report showing photos of the new products and explained the technical differences between DCA's existing products and the new ones they will be selling if the new machine were to be purchased. A few days later, ASRA submitted a proposal to Nadia explaining what they intended to do. Nadia liked their plan and told ASRA to proceed with the project. The two parties signed a contract for ASRA to do the work for $15,400. ASRA promised their report in three weeks.

Three weeks later, ASRA produced their report and their findings were promising. They estimated that DCA would be able to increase sales of its newly designed tools and accessories by about 8% in the first year of introduction and thereafter at a rate of 3% per year. That was an improvement over their currently forecasted sales growth of 2% per year. During the most recent year, DCA sales and variable cost of goods manufactured and sold were $2,750,000 and $1,760,000 respectively.[1] DCA estimated that even with the new machine, manufacturing costs per unit would remain the same. DCA also estimated that other fixed manufacturing, selling & administrative expenses are expected to remain the same and they will continue to pay their salespeople a 2% sales commission.

The old machine was purchased 5 years ago for $225,000. Currently, it could be sold for $130,000. Depreciation on the existing machine was being calculated using a 15-year straight-line schedule with the assumption of no residual salvage value. The new machine is expected to last for ten years and have a market value of approximately $18,000 at the end of its economic life. The new machine will be depreciated using a 10-year straight line schedule with the assumption of no residual salvage value.

DCA's marginal tax rate is 24% and its weighted average cost of capital is estimated to be 15%. DCA will pay for the machine with existing cash and a bank loan for $140,000. The bank loan carries an annual interest rate of 6%.

Required - Ahmad has asked you to work on the capital budgeting report indicating whether DCA should replace the existing machine or not. After reviewing reports and having discussions with DCA staff, you observed that the net working capital of DCA has consistently been about 20% of annual revenues.

1. Demonstrate a cash flow projection for 10 years.

2. Calculate Net Present Value and Internal Rate of Return.

3. How would your answer change if inflation is expected to be 3%?