Reference no: EM13274719

It's been 2 months since you took a position as an assistant financial analyst at Caledonia Products. Although your boss has been pleased with your work, he is still a bit hesitant about unleashing you without supervision. Your next assignment involves both the calculation of the cash flows associated with a new investment under consideration and the evaluation of several mutually exclusive projects. Given your lack of tenure at Caledonia, you have been asked not only to provide a recommendation but also to respond to a number of questions aimed at judging your understanding of the capital-budgeting process. The memorandum you received outlining your assignment follows: To: The assistant financial analyst From: Mr. V. Morrison, CEO, Caledonia Products Re: Cash Flow Analysis and Capital Rationing We are considering the introduction of a new product. Currently we are 34 percent in the marginal tax bracket with a 15 percent required rate of return or cost of capital. This project is expected to last 5 years and then, because this is somewhat of a fad product, be terminated. The following information describes this project: Cost of new plant and equipment $7,900,000 Shipping and installation costs $100,000 Unit Sales YEAR UNITS SOLD 1 70000 2 120000 3 140000 4 80000 5 60000 Sales Price per unit $300/unit in years 1 through 4, $260/unit year 5 Variable Cost per unit $180/unit Annual Fixed Costs $200,000 Working capital requirements There will be an initial working-capital requirement of $100,000 just to get into production. For each year, the total investment in net working capital will be equal to 10% of the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1 thru 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5. The depreciation method Use the simplified straight-line method over 5 years. Assume that the plant and equipment will have no salvage value after 5 years. a. should Caledonia focus on cash flows or accounting profits in making its capital-budgeting decisions? should the compny be interested in incremental cash flows, incremental profits, total free cash flows, or total profits. b.How does depriciation afect free cash flows? c. How do sunk cost affect the determination of cash flows? d. What is the projects initial outlay? e. what are the differential cash flows over the project's life? f. What is the terminal cash flow? g. Draw a cash flow diagram for this project. h. what is its new present Value i. What is its internal rate of return? j. should th project be accepted? why or why not? k. In Capital budgeting, risk can be measured from three perspectives. What are those three measure of a projects risk l. According to the CAPM, which measurment of risk is relevant what complictions does reality introdue into the capm vies of risk, and what does that mean for out view of the relevan measure of project risk? m Explain how simulation works what is the value in using a simultion approach. N. What is sensitivity analysis and what is its purpose?