Reference no: EM133027474

FIN 6310 Investment Management Assignment - University of Texas at Dallas, USA

Capital Budgeting Analysis (NPV and other rules) Project - Shrieves Casting Company

Shrieves Casting Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by Sidney Johnson and you, recently graduated MBA students. The production line would be set up in unused space in Shrieves' 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 expected to increase by 3% per year due to inflation. Further, to handle the new line, the firm's net working capital would have to increase by an amount equal to 12% of sales revenues. The firm's tax rate is 40%, and its overall weighted average cost of capital is 10%. Base on different capital budgeting decision rules decide if the project should be undertaken.

To help you structure the task, the CFO - Michael Jones has asked you to answer the following questions.

1. What is the Shrieves' depreciable basis? What are the annual depreciation expenses based on MACRS rates?

2. Calculate the annual sales revenues and costs (other than depreciation). Why is it important to include inflation when estimating cash flows?

3. Compute the annual incremental operating cash flow (Net Operating CF) including the depreciation and tax effects.

4. Estimate the required net working capital (the change) for each year, and the cash flow due to investments in net working capital.

5. Calculate the after-tax salvage cash flow of the equipment.

6. Calculate the project's net cash flows for each year. Based on these cash flows, what are the project's NPV, IRR, PI, and discounting payback period?

7. Do these indicators suggest the project should be undertaken? What other factors may impact on the capital budgeting decision?

8. With a 3% risk adjustment, should the project be accepted and why?

Note: MACRS annual rates are as follows:

1 0.3333

2 0.4445

3 0.1481

4 0.0741