Order Instructions

You are the Finance Manager for a growing Pet Food Manufacturer that is at capacity. You must decide on how to approach this situation with one choice being a machine upgrade that will increase productivity or move to a larger facility in which you would rent. The terms of each option are below.

 

Installed machine purchase option would require a $100,000 loan. This would be considered a capital budgeting project using MACRS 3 year depreciation (not real-life worthy but much easier for our purposes). The efficiency savings is expected to be $35,000 year 1, $60,000, $20,000 years 2-3 respectively. Tax rate 30%. Cost of capital is 9%. The machine can be sold for $20,000 at the end of year 3. NOTE: for non-Excel users I have provided the computation for cash flows below and NPV and IRR results. Excel users is you want to compute on your own as a challenge you can use my computations as a double check. The focus is on the application of the data received.

 

NPV CF0 CF1 CF2 CF3

$4,993 ($100,000) $34,499 $55,335 $34,666

IRR

11.76%

Rental option: Addditional rent and expenses of $24,000 per year but increased production of $32,000 per year. So…what is the present value of $8,000 per year for 3 years? The upfront (CF0) cost to this option is $14,000 in moving expenses. To compute the NPV Present Value computation use 9% cost of capital (I/Yr or rate). As with option 1 I have completed the answers and shown the inputs for you below.

 

NPV CF0 CF1 CF2 CF3

$6,250 ($14,000) $8,000 $8,000 $8,000

IRR

32.68%

As the finance manager which option would you suggest and why. PLUS, list one concern you might have to your choice that is not directly related to just numbers. (For example, if I am looking at a new car purchase I can compute the numbers but another concern I might have regarding my decision is the long term supply of oil from the Middle East and that impact on long term pricing).

 

If you use the textbook cite accordingly. If you have knowledge of this from work experience state that as part of your answer and no citations are needed).

 

 

 

Option 1 Excel results FYI

 

Chapters 12,13 Capital Budgeting 3 year Purchase price 100,000 Installation 0

100,000 Year 1 Year 2 Year 3 Year 4 Terminal value

EBITDA 35,000 60,000 20,000 0 Installed price 100,000

Depr 3 year 0.3333 0.4445 0.1481 0.0741 less acc. depr. 92,590

Depreciation Exp. 33,330 44,450 14,810 0 Book Value 7,410

EBT 1,670 15,550 5,190 0

Tax 501 4,665 1,557 0 Selling price 20,000

EAT 1,169 10,885 3,633 0 less BV 7,410

add depr back 33,330 44,450 14,810 0 Gain 12,590

OCF 34,499 55,335 18,443 0 Taxes owed 3,777

 

Tax rate 0.3 Selling price 20,000

WACC 9.00% less tax 3,777

NPV CF0 CF1 CF2 CF3 Net terminal 16,223

$4,993 ($100,000) $34,499 $55,335 $34,666

IRR

11.76%

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