3. The Auraria Pet Foods Company is considering the purchase of more flexible equipment that will allow them to create new products and will also be less expensive to operate than the current machinery. The existing equipment could be sold for $70,000 after taxes. As of today, management forecasts call for after-tax cash flows of $32,000 next year if the current machinery is retained. The cash flows are expected to increase at a rate of 6% per year for the next five years. The new machinery under consideration has a price of $90,000. It would be expected to produce cash flows of $35,000 next year, and the cash flows would grow by 8% per year for the next five years. The firm's WACC is 15%.
a. Calculate the net present value, IRR, and MIRR of the existing equipment. If the new equipment was not available, would it make more sense to keep the existing equipment or to sell it?
b. Calculate the net present value, IRR, and MIRR of the new equipment. If the new equipment is treated as a stand-alone investment, would it make sense to make the investment?
c. If you had to choose between keeping the existing equipment, or investing in the new equipment, which would you choose? Make the comparison by looking at both the NPVs and IRRs.
d. Calculate the incremental cost and annual after-tax cash flows if the new equipment is purchased. Evaluate the investment in the new equipment as a replacement project. Would you make the investment? Use the NPV, IRR and MIRR to explain your decision.
e. compare the NPV of the incremental cash flows to the difference between the NPVs of the new and old machines (NPVnew-NPVold). what conclusion can you draw from this comparison?
d. At what discount rate would you be indifferent between keeping the existing equipment and purchasing the new equipment? calculate the crossover rate using the IRR function. NOW, use the Goal Seek tool to determine the answer. Are they the same>
4. Chicago Turkey is considering a new turkey farm to service their western region stores. The stores currently require 500,000 turkeys per year, and they are purchased from various local turkey farms for an average price of $7 per bird. The managers believe that their new farm would lower the cost per bird to $6, while maintaining the average selling price of $10 per bird. However, due to the centralized structure of this operation, shipping expenses will increase to $1.50 per bird from the current $1.00. The firm will need to increase its inventory of live turkeys by $15,000. It will cost $150,000 to purchase the land, and $300,000 to construct the buildings and purchase equipment. In addition, labor expense will rise by $130,000 per year. The buildings and equipment will be depreciated using the straight-line method over five years to a salvage value of $100,000. After five years, the company will sell the farm for $300,000 ($100,000 for the buildings and equipment, $200,000 for the land). The firm's marginal tax rate is 35%, and note that land is not depreciable.
a. Calculate the initial outlay, after-tax cash flows, and terminal cash flow for this project.
b. If the WACC is 11%, calculate the payback period, discounted payback period, NPV, PI, IRR, and MIRR.
c. Management is uncertain about several of the variables in your analysis and have asked you to provide three different scenarios.
|
Scenario
|
Labor Expense
|
Salvage Value of Buildings
|
Salvage Value of Land
|
|
Best Case
|
$100,000
|
$150,000
|
$300,000
|
|
Expected Case
|
130,000
|
100,000
|
200,000
|
|
Worst Case
|
140,000
|
50,000
|
100,000
|
Create a scenario analysis showing the profitability measures for this investment using the information in the table above. (Note: The salvage value of the buildings is the actual forecasted salvage value, not that used for depreciation.)
5. The Chief Financial Officer of Eaton Medical Devices has determined that the firm's capital investment budget will be $5,000,000 for the upcoming year. Unfortunately, this amount is not sufficient to cover all of the positive NPV projects that are available to the firm.
|
Project
|
Cost
|
NPV
|
|
A
|
$628,200
|
$72,658
|
|
B
|
352,100
|
36,418
|
|
C
|
1,245,600
|
212,150
|
|
D
|
814,300
|
70,925
|
|
E
|
124,500
|
11,400
|
|
F
|
985,000
|
56,842
|
|
G
|
2,356,400
|
93,600
|
|
H
|
226,900
|
65,350
|
|
I
|
1,650,000
|
48,842
|
|
J
|
714,650
|
39,815
|
You have been asked to choose which investments, of those listed in the table, should be made.
a. Using the Solver, determine which of the above projects should be included in the budget if the firm's goal is to maximize shareholder wealth. (Note: Make sure to set the Solver options to Assume Linear Model.)
b. Now assume that the CFO has informed you that projects A and B are mutually exclusive, but one of them must be selected. Change your Solver constraints to account for this new information and find the new solution.(use the same option as in part a)
c. Ignore the constraints from part b. The CFO has now informed you that Project I is of great strategic importance to the survival of the firm. For this reason it must be accepted. Change your Solver constraints to account for this new information and find the new solution.(use the same option as in part a)