You will see similar case study in google search but the values are totally different.Please dont copy paste the same answers. ?You can answer these questions one by one,?or use Excel to est

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Mini Case 2 (Ch11) – Student-2

Essentials of Managerial Finance (The University of Tennessee at Chattanooga)

Studocu is not sponsored or endorsed by any college or university

Mini Case 2 (Ch11) – Student-2

Essentials of Managerial Finance (The University of Tennessee at Chattanooga)

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Mini Case 2 (Ch11)

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 machinery’s invoice price would be approximately $310,000, 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 will be sold

at its expected salvage value of $25,000 after 4 years of use.

The new line would generate incremental sales of 1,400 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 next years projected sales revenues. The firm’s tax rate is 40%, and its overall

weighted average cost of capital is 10%.

a. Define “incremental cash flow.” 3 pt

(2.) Suppose the firm had spent $100,000 last year to rehabilitate the production line site. Should this be

included in the analysis? Explain. 3 pt

(1.) Should you subtract interest expense or dividends when calculating project cash flow? Why or why not? 3 pt

The projected cash flows for the company with the project minus the projected cash flows for the company without the

project.

No, you should not subtract interest expense or dividends when calculating the project cash flow because the intrest and

dividends are already included in the project's weighted average of the costs of debt (WACC), in other words subtracting the

interest and dividends would result in double counting interest costs.

No, because this is a sunk cost, meaning this is a cost that was incurred in the past and cannot be reovered regarless of

whether or not the project is accepted.

Yes, by accepting the project the company will not receive the $25,000 per year for leasing the plant space, so this is an

opportunity cost.

(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? 3 pt

(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? 3 pt

Yes, this is considered an externality. Externalities are the effects of a project on other parts of the firm or on the

environment. A decrease in sales of other product lines is a negative externality and should be considered a cost to the

project.

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Analysis of New Expansion Project (INPUT DATA is shown below)

Part I: Input Data

Equipment cost $310,000

Shipping charge $10,000

Installation charge $30,000

Economic Life 4

Salvage Value $25,000

Tax Rate 40%

Cost of Capital 10%

Units Sold 1,400

Sales Price Per Unit $200 Prices will increase with inflation (3%) each year (round to 2 dec)

Incremental Cost Per Unit $100 Costs will increase with inflation (3%) each year (round to 2 dec)

Net Working Capital/Sales 12% NWC = 12% of next year's expected sales (round to 0 decimals)

Inflation rate 3%

$350,000

Year

Depreciation

% x

Depreciable

Basis = Depr.

Remaining

Book

Value

1 33.00% $350,000 $115,500 $234,500

2 45.00% $350,000 $157,500 $77,000

3 15.00% $350,000 $52,500 $24,500

4 7.00% $350,000 $24,500 $0

Year 1 Year 2 Year 3 Year 4

Units Sold 1,400 1,400 1,400 1,400

Unit price (increases at inflation rate) $200.00 $206.00 $212.18 $218.55

Unit cost (increases at inflation rate) $100.00 $103.00 $106.09 $109.27

Annual Operating Cash Flows Year 0 Year 1 Year 2 Year 3 Year 4

Sales N/A $280,000 $288,400 $297,052 $305,964

– Costs 140,000 144,200 148,526 152,982

– Depreciation 115,500 157,500 52,500 24,500

= Operating income before taxes (EBIT) $24,500 ($13,300) $96,026 $128,482

– Taxes (40%) 9,800 0 38,410 51,393

= Earnings after Tax $14,700 ($13,300) $57,616 $77,089

+ Depreciation 115,500 157,500 52,500 24,500

= Net Operating CF $130,200 $144,200 $110,116 $101,589

c. Calculate the annual sales revenues and costs (other than depreciation). Why is it important to include

inflation when estimating cash flows? [Fill in the table using Excel formula functions.] 4 pt

*Depreciable Basis =

NOTE: YOU NEED TO USE THE DATA CELLS BELOW AS INPUT SOURCES TO SOLVE FOR

QUESTIONS SUCH AS NPV; OPER CF's; TERMINAL CF; etc.

b. Disregard the assumptions in Part a. What is Shrieves' depreciable basis? What are the annual

depreciation expenses? [Fill in the table using Excel formula functions.] 4 pt

d. Construct annual incremental operating cash flow statements. [Fill in the table using Excel formula functions.] 8 pt

Find Annual Depreciation Expense => *Depreciable Basis = Equipment + Freight + Installation

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Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Sales $280,000 $288,400 $297,052 $305,964 $0

NWC (% of next year's sales) $33,600 $34,608 $35,646 $36,716 $0

CF due to investment change in NOWC) ($33,600) ($1,008) ($1,038) ($1,069) $36,716

Calculate the after-tax Salvage Value cash flows:

After-tax Salvage Value

Based on

facts in case:

Salvage value in Year 4 $25,000

– Book value 0

Gain or loss $25,000

Tax on salvage value 10,000

Salvage Cash Flow (Net terminal CF) $15,000

Year 0 Year 1 Year 2 Year 3 Year 4

Machine's Price (including shipping & installation): ($350,000) 0 0 0 0

Net Operating Cash Flows (from above) 0 $130,200 $144,200 $110,116 $101,589

CF due to investment change in NOWC (33,600) (1,008) (1,038) (1,069) 36,716

Salvage Cash Flows (Net Terminal CF) 0 0 0 0 15,000

Net Cash Flows ($383,600) $129,192 $143,162 $109,046 $153,305

WACC 10%

Accept/Reject

$38,800 Accept

14.534% Accept 0 1 2 3 4

12.682% Accept ($383,600) $129,192 $143,162 $109,046 $153,305

3.01 Accept 119,951

173,226

171,955

PV= ($35,273) Total FV $618,436

Find Payback (show calculations below): 2 pt MIRR = 12.68%

(-383,600 + 129,192 + 143,162 + 109,046 = -2,200) > 3 +

(2,200/153,305) Based on all info should you

Accept/Reject? Why? 2 pt I would accept because the

project has a positive NPV, IRR

and MIRR are greater than the

cost of capital, and the project is

payed back within it's economic

f. Calculate the Net Projected Cash Flows for each year in the table below (WACC = 10%): 5 pt

IRR =

MIRR =

Payback Period =

NPV =

g. Based on these Net Cash Flows, what are the project’s NPV, IRR, MIRR, and Payback? Do you Accept or Reject? 6 pt

e. Estimate the required net working capital for each year, and the cash flow due to investments in Net Working

Capital (NWC). 4 pt

Show how MIRR is found below:

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Sensitivity Analysis

Sensitivity of NPV and to Variations in Input Variables

% Deviation 10.0% % Deviation 1400 % Deviation $25,000

from NPV from Units NPV from SALVAGE NPV

Base Case WACC Accept Base Case Sold Accept Base Case Value Accept

-30.0% 7.0% $68,153 -30.0% 980 -$61,789 -30.0% 17,500 $35,726

-20.0% 8.0% $58,008 -20.0% 1120 -$25,289 -20.0% 20,000 $36,751

-10.0% 9.0% $48,230 -10.0% 1260 $7,392 -10.0% 22,500 $37,775

0.0% 10.0% $38,800 0.0% 1400 $38,800 0.0% 25,000 $38,800

10.0% 11.0% $29,703 10.0% 1540 $69,838 10.0% 27,500 $39,825

20.0% 12.0% $20,923 20.0% 1680 $96,480 20.0% 30,000 $40,849

30.0% 13.0% $12,445 30.0% 1820 $123,121 30.0% 32,500 $41,874

Create an Excel "Data Table" below to find the NPVs for changes in WACC, unit sales, and salvage value holding other

things constant–changing one variable at a time. You can use these results to produce the sensitivity analys as shown below.

Your BASE Case for WACC is 10%, i.e., 0.0% Deviations from Base Case. 9 pt

1. Measured by the standard deviation or CV of NPV, IRR, or MIRR; 2. Measured by the firm's corporate beta; 3. Measured

by the project's market beta. The stand-alone risk and the corporate risk are usually correlated as are corporate risk and

market risk.

Market risk is theoretically best in most situations, but creditors, customers, suppliers, and employees are more affected by

corporate risk. Stand-alone risk is the easiest to measure and the msot intuitive.

(2.) Perform a sensitivity analysis on how the Cost of Capital (WACC); Unit Sales; and Salvage Value affects the NPV of

the project. Assume that each of these variables can vary from its base-case (expected) value by plus and minus 10%, 20%,

and 30%:

(2.) How is each of these risk types measured, and how do they relate to one another? 3 pt

j. (1.) What is sensitivity analysis? 3 pt

Sensitivity analysis shows how changes in a variable such as unit sales affect NPV or IRR. It is typically used to answer "what

if" questions.

1. Stand-alone risk; 2. Corporate risk; 3. Market (or beta) risk.

Risk is the uncertainty about a project's future profitability and can be measured by the changes in NPV, IRR, and beta. The

assessment of risk at times can require the analysis of historical data, but is usually based on subjective judgments.

i. (1.) What are the three types of risk that are relevant in capital budgeting? 3 pt

h. What does the term ”risk” mean in the context of capital budgeting; to what extent can risk be quantified; and

when risk is quantified, is the quantification based primarily on statistical analysis of historical data or on

subjective, judgmental estimates? 4 pt

(3.) How is each type of risk used in the capital budgeting process? 3 pt

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Evaluating Risk: Sensitivity Analysis: Place Sensitivity Graph is space below:

Summarize the above Data Tables NPV's into the table below: 3 pt

Deviation NPV Deviation from Base Case

from Units

Base Case WACC Sold Salvage

-30% $68,153 ($61,789) $35,726

-20% $58,008 ($25,289) $36,751

-10% $48,230 $7,392 $37,775

0% $38,800 $38,800 $38,800

10% $29,703 $69,838 $39,825

20% $20,923 $96,480 $40,849

30% $12,445 $123,121 $41,874

Range ($62,000) $124,000

<= Place graph here

Series 3 = SalvageSeries 2 = UnitsSeries 1 = WACC

USE THIS TABLE TO

CREATE

SENSITIVITY GRAPH

(3.) Briefly discuss the results of your Sensitivity Graph. What is the primary weakness of sensitivity analysis? What is its

primary usefulness? 3 pt

The increase in units sold has the most dramatic influence on the NPV, which indicates that units sold is an important

variable. The primary weakness of sensitivity analysis is that it does not reflect diversification, it does not reflect the

probability of change in a variable, and it ignores relationships among variables.

Sensitivity Analysis Graph 3 pt

-$100,000

-$50,000

$0

$50,000

$100,000

$150,000

-30% -20% -10% 0% 10% 20% 30% Range

Sensitivity Analysis

Deviation from WACC

NPV Deviation from Base Case Units Sold

NPV Deviation from Base Case Units Salvage

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Scenario Analysis

Best Base Worst

NPV here=> $38,800 $240 $200 $160 Unit Prices *Trying to use the What If in excel Best 1,750 192,464 57,127 (78,210)

Base 1,400 166,654 38,800 (89,054)

Worst 1,050 140,843 20,473 (99,897)

Units Sold

Expected NPV = Sum of the Probability*NPV for each scenario 42542

Scenario Probability Unit Sales Unit Price NPV NPV*Pr

Best Case 25% 1,750 $240 $227,481 $56,870 *manually calculated

Base Case 50% 1,400 $200 $38,800 $19,400

Worst Case 25% 1,050 $160 ($171,999) ($43,000)

Expected NPV = $33,271

The wide range of possibilities and the significant negative NPV for the worst case scenario suggest to me that this is a fairly

risky project. However, the expected NPV is still positive, which leaves me inclined to accept the project.

k. NOW, assume that Sidney Johnson is confident of her estimates of all the variables that affect the project’s cash flows

except unit sales and sales price: If product acceptance is poor, unit sales would be only 1050 units a year and the

unit price would only be $160; a strong consumer response would produce sales of 1,750 units and a unit price of

$240. Sidney believes that there is a 25% chance of poor acceptance, a 25% chance of excellent acceptance, and

a 50% chance of average acceptance (the base case where Units = 1400; Unit Price = $200).

(1.) What is scenario analysis? How is it different than Sensitivity Analysis? 3 pt

(3.) Use the worst-, most likely (base), and best-case NPVs and probabilities of occurrence to find project’s Expected NPV.

2 pt

Scenario Analysis: Based on your answers in (2) above show the Best, Base, and Worst Case results in

the Table below.

(2.) What is the worst-case NPV? The best-case NPV? Use the two variable Data Table for sensitivity analysis (here you

only need the NPV from the Best-Best Case, Base-Base Case, and Worst-Worst Case); OR, you may use Excel's scenario

analysis. 6 pt

Scenario analysis examines several possible situations typically the worst, most likely, and best case scenarios. Scenario

analysis is different from sensitivity analysis in that it considers fewer possible outcomes and assumes that inputs are perfectly

correlated.

Here is a two variable Data Table (you only need values in the "highlighted" boxes):

(3.) How can we use this information to analyze the risk in our Accept/Reject Decision? 3 pt

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