Reference no: EM13371111

Case

Axolotl Corporation is a relatively small company in Eastern Washington that produces avionic parts and equipment for both the commercial airline industry and the military. The company recently won several contracts in 2013 for production starting in 2014. As a result, they need to expand their production and testing capabilities. As CFO of Axolotl, you are responsible for conducting the analysis of the capital project needed to allow the company to fulfill the contracts.

Detailed discussions with the sales and marketing personnel indicate that sales in the first year would be $55 million and grow at 3% per year through the ten year life of the project. Accounting has indicated that the sales, general and administrative costs would be fixed at $5.5 million for the life of the project. Accounting also estimates working capital needs at 25% of revenue. Engineering and Manufacturing have indicated that the cost of goods will be 62% of sales.

The equipment is estimated to cost $53 million with an additional $40 million for installation. It has a ten year economic life and falls within the 7 year MACRS class for depreciation purposes. Engineering estimates that it can be sold for $2.5 million at the end of the project life.

The new production facilities will also require a new building at a cost of $20 million. The building has a 39 year life and is required to use straight line depreciation. The market value of the building at the end of the project is estimated to be $11 million.

Axolotol's marginal tax rate is 35% and the project will initially use 15% as the cost of capital. Further refinement will use the book value weighted average cost of capital you will calculate later.

Now that the contract is signed, determine whether this project will be profitable for the company. The board of directors requires all project analyses to include the net present value, internal rate of return, payback and profitability index. They also require an analysis of projects using +/-10% for revenue.

Since the information for a complete report is not presented here, your written report should include a discussion of the project as well as how the cash flows are determined and measures of project desirability are determined. Also, discuss the results of the sensitivity analysis and the implications of changes in revenue.