Solution to Integrated Case
Allied Components Company
Basics of Capital Budgeting
You recently went to work for Allied Components Company, a supplier
of auto repair parts used in the after-market with products from
Daimler, Chrysler, Ford, and other automakers. Your boss, the chief
financial officer (CFO), has just handed you the estimated cash flows
for two proposed projects. Project L involves adding a new item to the
firm’s ignition system line; it would take some time to build up the
market for this product, so the cash inflows would increase over time.
Project S involves an add-on to an existing line, and its cash flows
would decrease over time. Both projects have 3-year lives, because
Allied is planning to introduce entirely new models after 3 years.
Here are the projects’ net cash flows (in thousands of dollars):
Depreciation, salvage values, net working capital requirements, and
tax effects are all included in these cash flows.
The CFO also made subjective risk assessments of each project,
and he concluded that both projects have risk characteristics that
are similar to the firm’s average project.
Allied’s WACC is 10%.
must determine whether one or both of the projects should be
The Basics of Capital Budgeting