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 ShrievesĂ˘â‚¬â„˘ main plant. The machineryĂ˘â‚¬â„˘s 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 firmĂ˘â‚¬â„˘s net working capital for each year would have to equal to 12% of next yearĂ˘â‚¬â„˘s sales revenues. The firmĂ˘â‚¬â„˘s tax rate is 40%,and its discount rate is 10%.
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- Define Ă˘â‚¬Ĺ“incremental cash flow.Ă˘â‚¬Âť
- Should you subtract interest expense when calculating project cash flow?
- Suppose the firm had spent $100,000 last year to rehabilitate the production line site. Should this cost be included in the analysis? Explain.
- Now assume that the plant space could be leased out to another firm at $25,000per year. Should this be included in the analysis? If so, how?
- Finally, assume that the new product line is expected to decrease sales of the firmĂ˘â‚¬â„˘s other lines by $50,000 per year. Should this be considered in the analysis?