Reference no: EM133045783
California Pellet Mill Company, a major manufacturer of pellet mills, has introduced a new pellet mill that is rated at 10.6 tons per hour. Based on the current production efficiency, the actual production rate would be 8.82 tons per hour. The new pellet mills would cost $120,000 each, including installation. If four new mills are purchased, a one-time $15,000 improvement in the steam line to the mills would be required. The new pellet mills would be depreciated over a five-year period as follows: First year 20%, second year 32%, third year 19.2%, fourth and fifth year 11.52% and 5.76% in the sixth year. The four old machines have been fully depreciated but could be sold as junk for $10,000 each. If the four new mills are purchased there would also be a net increase in the working capital of $12,000.
Among the other capital projects, the plant capital budgeting committee thinks that the purchase of the new pellet mills should be given a high priority. Paschall, the Plant Manager, knows that he must present any capital budgeting requests before the divisional capital budgeting committee. Each year he is given certain guidelines for the preparation of capital requests. Among these guidelines are the specific instructions for preparing the capital budget requests. It was noted that in this year's instructions that the cost of capital for plant production is 16% and the company has a combined state and federal tax rate of 38 percent for this Kentucky plants.
The Louisville plant operates five days a week and 50 weeks a year (10 holidays) with the pellet line averaging 12 hours of operation per day. The average sales price per ton of pet food is $280. The raw materials cost $152 per ton, and operating costs-including all overhead, selling and administrative expenses-are $108 per ton. Both sales costs are expected to increase by 6% per year over the seven-year economic life of these mills. At the end of their economic life the mills are expected to have a salvage value of $10,000 each.
Questions:
-Determine the initial net cash outlfow for this project.
-Determine the net cash flows (year 1 to 7) if the new pellet mills are purchased.
-Calculate the IRR for the pellet mill project.
-Should AGC invest in the new pellet mills? Defend your answer.
-Give two reasons besides those presented in thisncase migh this project be unacceptable?