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Copy_of_Ch11_Mini_Case

# Copy_of_Ch11_Mini_Case - Chapter 11 Mini Case Situation...

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4/11/2010 Chapter 11 Mini Case Situation Analysis of New Expansion Project Part I: Input Data Equipment cost \$200,000 Key Output: NPV = \$88,026 Shipping charge \$10,000 Installation charge \$30,000 Economic Life 4 Salvage Value \$25,000 Tax Rate 40% Cost of Capital 10% Units Sold 1,250 Sales Price Per Unit \$200 Incremental Cost Per Unit \$100 NWC/Sales 12% Inflation rate 3% Shrieves Casting Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by Sidney Johnson, a recently graduated MBA. 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%. a. Define “incremental cash flow.” Answer: See Chapter 11 Mini Case Show (1.) Should you subtract interest expense or dividends when calculating project cash flow? Answer: See Chapter 11 Mini Case Show (2.) Suppose the firm had spent \$100,000 last year to rehabilitate the production line site. Should this be included in the analysis? Explain. Answer: See Chapter 11 Mini Case Show (3.) Now assume that the plant space could be leased out to another firm at \$25,000 per year. Should this be included in the analysis? If so, how? Answer: See Chapter 11 Mini Case Show (4.) Finally, assume that the new product line is expected to decrease sales of the firm’s other lines by \$50,000 per year. Should this be considered in the analysis? If so, how? Answer: See Chapter 11 Mini Case Show

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Annual Depreciation Expense Depreciable Basis = Equipment + Freight + Installation Depreciable Basis = \$240,000 Year % x Basis = Depr. 1 0.33 \$240,000 \$79,200 \$160,800 2 0.45 240,000 108,000 52,800 3 0.15 240,000 36,000 16,800 4 0.07 240,000 16,800 0 d. Construct annual incremental operating cash flow statements. Annual Operating Cash Flows Year 1 Year 2 Year 3 Year 4 Units 1,250 1,250 1,250 1,250 Unit price \$200.00 \$206.00 \$212.18 \$218.55 Unit cost \$100.00 \$103.00 \$106.09 \$109.27 Sales \$250,000 \$257,500 \$265,225 \$273,182 Costs 125,000 128,750 132,613 136,591 Depreciation 79,200 108,000 36,000 16,800 Operating income before taxes (EBIT)
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Copy_of_Ch11_Mini_Case - Chapter 11 Mini Case Situation...

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