4/11/2010

Chapter 11 Mini Case

Situation 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 machinerys 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 firms net working capital would have to increase by an amount equal to 12% of sales revenues. The firms tax rate is 40%, and its overall weighted average cost of capital is 10%.

Analysis of New Expansion Project Part I: Input Data Equipment cost Shipping charge Installation charge Economic Life Salvage Value Tax Rate Cost of Capital Units Sold Sales Price Per Unit Incremental Cost Per Unit NWC/Sales Inflation rate $200,000 $10,000 $30,000 4 $25,000 40% 10% 1,250 $200 $100 12% 3% Key Output: NPV =

Depreciable Basis = Equipment + Freight + Installation Depreciable Basis = Remaining Book Value $0 0 0 0

Year 1 2 3 4

% 0.33 0.45 0.15 0.07

Basis $0 0 0 0

Depr. $0 0 0 0

Annual Operating Cash Flows Year 1 Units Year 2 Year 3 Year 4

Unit price Unit cost Sales Costs Depreciation Operating income before taxes (EBIT) Taxes (40%) EBIT (1 T) Depreciation Net operating CF e. Estimate the required net working capital for each year, and the cash flow due to investments in net working capital. Annual Cash Flows due to Investments in Net Working Capital Year 0 Sales NWC (% of sales) CF due to investment in NOWC) Hypothetical: If sold after 3 years for Based on facts in case: Salvage value Book value Gain or loss Tax on salvage value Net terminal cash flow Year 1 Year 2 Year 3 Year 4

After-tax Salvage Value

$25,000

$10,000

Projected Net Cash Flows

Year 0 Investment Outlay: Long Term Assets Operating Cash Flows CF due to investment in NWC Salvage Cash Flows Net Cash Flows NPV IRR Year 1 Year 2 Year 3 Year 4

PV of InflowsTV of Inflows $0 $0 Years 0 1 2 3 4

Find MIRR
Net Cash Flows

PV=

TV =

To find MIRR, we could now find the discount rate that equates the PV and TV. But it is easier to use the MIRR function. MIRR =