RWE Enterprises: Expansion Project analysis

RWE Enterprises, Inc. (RWE) is a small manufacturing firm located in the hills just outside Adelaide, South Australia. The firm is engaged in the manufacture and sale of feed supplements used by cattle raisers. The product has a molasses base but is supplemented with minerals and vitamins that are generally thought to be essential to the health and growth of beef cattle. The final product is put in 50kg or 90kg tubs that are then made available for the cattle to lick as desired. The material in the tub becomes very hard, which limits the animals' consumption.

The firm has been running a single production line for the past five years and is considering the addition of a of a new line. The addition would expand the firm's capacity by almost l20% since the new equipment requires a shorter down time between batches. After each production run, the boiler used to prepare the molasses for the addition of minerals and vitamins must be heated to 85 degree Celsius and then must be cooled down before beginning the next batch. The total production run entails about four hours and the cool-down period is two hours (during which time the whole process comes to a halt). Using two production lines would increase the overall efficiency of the operation since workers from the line that is cooling down could be moved to the other line to support the 'canning' process involved. Including the feed tubs.

The second production line equipment would cost $3 million to purchase and install and would have an estimated life of 10 years at which time it could be sold for an estimated after-tax scrap value of $ 200,000. Furthermore, at the end of five years the production line would have to be refurbished at an estimated cost of $2 million. RWE's management estimates that the new production line would add $ 700, 000 per year in after-tax cash flow to the firm. The 10-year cash flows for the line are as follows:

YEAR CASH FLOW

0 - $ 3000 000

1 700 000

2 700 000

3 700 000

4 700 000

5 -1 300 000

6 700 000

7 700 000

8 700 000

9 700 000

10 900 000

a) If RWE uses a 105 discount rate to evaluate investments of this type, what is the net present value of the project? What does this NPV indicates about the potentiasl value RWE might create by purchasing the new production line?

b) Calculate the Payback and discounted Payback for the proposed investment. Interpret your findings.