Ask Question, Ask an Expert


Ask Basic Finance Expert

problem: Central Florida Computer Company (CFCC), a leading manufacturer of IBM look-alike computers, is considering the installation of a new production line to manufacture clones of IBM computers. Mike Stoltz, the newest financial analyst, is evaluating the proposal in the spring of 19x0, with anticipated initial investment occurring late in 19x0 & the first revenue arriving at the end of 19x1. The proposed portion of the plant that company owns was identified last year by an outside consultant at a cost of USD 60,000. At the moment, a portion of this plant is vacant. The 10,500 square feet required for the assembly line represents 25 percent of the entire plant. The plant originally cost USD 1,450,000 12 years ago & is being depreciated over 20 years. Warehouse space currently leases for USD 11 per square foot per year, however the company has strict policy forbidding the renting or leasing out of any of its vacant production facilities.

CFCC must spend USD 1,100,000 on equipment for the line, plus USD 10,000 in shipping & installation costs. The equipment manufacturer is willing to guarantee these expenses, so CFCC's management is certain of these cash flows. The machines are expected to have a five-year economic life. For tax purposes, they are classified as special manufacturing tools, & hence fall into a three-year MACRS depreciation schedule. (This schedule requires percentage depreciations of 33 percent, 45 percent, 15 percent, & 7 percent for each of the first four years, respectively.)

CFCC's marketing department feels that sales for the division will depend upon the state of the economy. Exhibit 1 details the marketing department's sales estimates.

The marketing department expects that, given the state of economy, unit sales will be flat over the five-year life of the assembly line, but prices, and hence revenues, are expected to increase with inflation by 6 percent per year over the life of the line. The initial selling price in 19x1 is expected to be USD 1,500 per unit.

The engineering department expects that fixed costs (excluding depreciation) will be constant USD 70,000 per year & that variable component costs (parts assembled to manufacture the computers) & labor costs will be 45 percent of revenues. The department is virtually certain of both of these estimates. CFCC's marginal tax rate during the period is expected to remain at 38 percent.

The new assembly line will require an increase in the level of CFCC's raw material inventories, finished goods inventory, & accounts receivable. The expected increase in current assets will be somewhat offset by a corresponding increase in current liabilities. The resulting increase in net working capital will require an investment of USD 30,000 in 19x0 prior to 19x1 sales. Beginning in 19x1, additional annual increases in net working capital will be required; they will vary directly with annual changes in revenue at a rate of 11.25 percent per dollar of marginal revenue. Thus, the change in net working capital in 19x1 will be 11.25 cents per dollar of 19x2 revenue increases over the 19x1 revenue level. All of the working capital investments will be recoverable at the end of project's life.

At the end of the line's operating life, the line will be closed down. CFCC expects to turn the plant square footage over to another project. The assembly line machinery, on the other hand, will be sold for its estimated salvage value. The engineers have provided the estimates of terminal value before taxes (Exhibit 1).

CFCC's stock is traded on the over-the-counter market at USD 30 per share, with an estimated beta of 1.5. Analysts expect that the company will pay USD 2.1 in dividends per share in 19x1; dividends have grown 9 percent annually for the past 10 years. Currently, Treasury securities yield 7 percent & the Standard & Poor's 500 Index is expected to return 12.5 percent annually for the next several years. CFCC borrows from a local bank at 11 percent.

CFCC's operating committee has always maintained the company's book value capital structure at what it believes is the company's optimal or target capital structure. Exhibit 2 provides the company's current capital structure. 


Exhibit 2

Central Florida Computer Company 


Forecasts of Sales and Terminal Value 


State of Economy 



Terminal Value (Selling Price) 




USD 100,000

Slow growth 




Strong growth 




Central Florida Computer Company 


Capital Structure 




Long-term debt 

USD 3,500,000

Capital stock paid in 


Retained earnings 


Perform a sensitivity analysis on the sales & salvage value assumptions - that is, fix the salvage value at the most likely value & estimate the effect of a value 70, 80, 90, 100, 110, 120, & 130 percent of the most likely sales assumption. Now hold sales at its most likely value & examine the effect of a value 70, 80, 90, 100, 110, 120, & 130 percent of the most likely salvage value assumption. Graph the results on the same axis. How do you interpret this information?

Basic Finance, Finance

  • Category:- Basic Finance
  • Reference No.:- M916592

Have any Question? 

Related Questions in Basic Finance

Given the following informationcurrent stock price 35stock

Given the following information: Current stock price $35 Stock beta: 2 Risk-free rate: 4% Market risk premium: 6% Expected dividend, D 1 : $3.00 Expected long-run growth rate of dividends: 6% What is the required return ...

1 what types of risks should shareholder wealth-maximizing

1. What types of risks should shareholder wealth-maximizing managers seek to offset in a firm they are managing? Why? 2. How can the acquisition of additional information be an effective tool of risk management? Give an ...

1 what are the responsibilities and typical payoff for a

1. What are the responsibilities and typical payoff for a general partner in a venture capital limited partnership? 2. Distinguish between positive covenants and negative covenants in venture capital investment contracts ...

Look again at figure 83 on page 237 and answer the

Look again at Figure 8.3 on page 237 and answer the following questions. a. Why is the demand curve for foreign exchange downward sloping? b. Why is the supply curve for foreign exchange upward sloping? c. Who would be i ...

Congratulationsnbsp due to your education skills you have

Congratulations!  Due to your education, skills you have learned, and hard work, you have successfully managed your fledgling start-up company to the point where you are seriously considering an Initial Public Offering ( ...

1 what are time-series research designs and how are they

1. What are time-series research designs, and how are they used to learn about changes in behavior over time? 2. What types of independent variables can be used in participant-variable research designs, and what conclusi ...

Describe the essentials of financial engineering some

Describe the essentials of financial engineering ? Some companies have come unstuck dealing financially engineered instruments. Why do you suppose this is? Banks pay big salaries to financial engineers. What traits do th ...

Compare and differentiate between the financial and

Compare and differentiate between the financial and investment DECISIONS MAKING?

1 small savers can usually receive a higher interest rate

1. Small savers can usually receive a higher interest rate from money market mutual funds than from bank savings accounts. So, how are banks able to attract small savers? 2. Financial journalist David Wessel has describe ...

1 based on the following information construct a

1. Based on the following information, construct a traditional financial institution balance sheet AND a balance sheet including off-balance sheet items. Market value of assets = 200                                      ...

  • 4,153,160 Questions Asked
  • 13,132 Experts
  • 2,558,936 Questions Answered

Ask Experts for help!!

Looking for Assignment Help?

Start excelling in your Courses, Get help with Assignment

Write us your full requirement for evaluation and you will receive response within 20 minutes turnaround time.

Ask Now Help with Problems, Get a Best Answer

WalMart Identification of theory and critical discussion

Drawing on the prescribed text and/or relevant academic literature, produce a paper which discusses the nature of group

Section onea in an atwood machine suppose two objects of

SECTION ONE (a) In an Atwood Machine, suppose two objects of unequal mass are hung vertically over a frictionless

Part 1you work in hr for a company that operates a factory

Part 1: You work in HR for a company that operates a factory manufacturing fiberglass. There are several hundred empl

Details on advanced accounting paperthis paper is intended

DETAILS ON ADVANCED ACCOUNTING PAPER This paper is intended for students to apply the theoretical knowledge around ac

Create a provider database and related reports and queries

Create a provider database and related reports and queries to capture contact information for potential PC component pro