Case Study 3 Constructed Response Answer Hocus Pocus Company wants to increase sales by adding a new product line. The company is considering three different projects. However, its capital budget is limited to $1,500,000. In addition, the company requires a rate of return of 10%. The information concerning the three product lines is given below. Net Initial Investment Budgeted Income Statement for the next five years: Sales Cost of Goods Sold Gross Margin Marketing and Administrative Expenses Net Income Broomsticks $1,170,000 $500,000 80,000 420,000 100,000 ? Magic Wands $983,000 *Assume all amounts stated on the budgeted income statement are cash items. $450,000 50,000 400,000 130,000 ? Crystal Balls $2,210,000 Required a) Determine the net present value for each project assuming all cash flows cease after five years. $650,000 32,000 618,000 22,000 ?

Case Study 3 Constructed Response Answer Hocus Pocus Company wants to increase sales by adding a new product line. The company is considering three different projects. However, its capital budget is limited to $1,500,000. In addition, the company requires a rate of return of 10%. The information concerning the three product lines is given below. Net Initial Investment Budgeted Income Statement for the next five years: Sales Cost of Goods Sold Gross Margin Marketing and Administrative Expenses Net Income Broomsticks $1,170,000 $500,000 80,000 420,000 100,000 ? Magic Wands $983,000 *Assume all amounts stated on the budgeted income statement are cash items. $450,000 50,000 400,000 130,000 ? Crystal Balls $2,210,000 Required a) Determine the net present value for each project assuming all cash flows cease after five years. $650,000 32,000 618,000 22,000 ?

Managerial Accounting

15th Edition

ISBN:9781337912020

Author:Carl Warren, Ph.d. Cma William B. Tayler

Publisher:Carl Warren, Ph.d. Cma William B. Tayler

Chapter12: Capital Investment Analysis

Section: Chapter Questions

Problem 3E: Average rate of returnnew product Hana Inc. is considering an investment in new equipment that will...

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Average rate of returnnew product Hana Inc. is considering an investment in new equipment that will be used to manufacture a smart-phone. The phone is expected to generate additional annual sales of 10,000 units at 300 per unit. The equipment has a cost of 4,500,000, residual value of 500,000, and a 10-year life. The equipment can only be used to manufacture the phone. The cost to manufacture the phone follows: Determine the average rate of return on the equipment.
INTEGRATED CASE ALLIED FOOD PRODUCTS CAPITAL BUDGETING AND CASH FLOW ESTIMATION Allied Food Products is considering expanding into the fruit juice business with a new fresh lemon juice product. Assume that you were recently hired as assistant to the director of capital budgeting, and you must evaluate the new project. The lemon juice would be produced in an unused building adjacent to Allied's Fort Myers plant; Allied owns the building, which is fully depreciated. The required equipment would cost 200,000, plus on additional 40,000 for shipping and installation. In addition, inventories would rise by 25,000, while accounts payable would increase by 5,000. All of these costs would be incurred at t = 0. By a special ruling, the machinery could be depreciated under the MACRS system as 3-year property. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The project is expected to operate for 4 years, at which time it will be terminated. The cash inflows are assumed to begin 1 year after the project is undertaken, or at t = 1, and to continue out to t = 4. At the end of the project's life (t = 4), the equipment is expected to have a salvage value of 25,000. Unit sales are expected to total 100,000 units per year, and the expected sales price is 2.00 per unit. Cash operating costs for the project (total operating costs less depreciation) are expected to total 60% of dollar sales. Allied's tax rate is 40%, and its WACC is 10%. Tentatively, the lemon juice project is assumed to be of equal risk to Allied's other assets. You have been asked to evaluate the project and to make a recommendation as to whether it should be accepted or rejected. To guide you in your analysis, your boss gave you the following set of tasks/ questions: a. Allied has a standard form that is used in the capital budgeting process. (See Table IC 12.1.) Part of the table has been completed, but you must replace the blanks with the missing numbers. Complete the table using the following steps: 1. Fill in the blanks under Year 0 for the initial investment outlays: CAPEX and NOWC. 2. Complete the table for unit sales, sales price, total revenues, and operating costs excluding depreciation. 3. Complete the depreciation data. 4. Complete the table down to after-tax operating income and then down to the project's operating cash flows, EBIT(1 T) + DEP. 5. Fill in the blanks under Year 4 for the terminal cash flows and complete the project free cash flow line. Discuss the recovery of net operating working capital. What would have happened if the machinery had been sold for less than its book value? b. 1. Allied uses debt in its capital structure, so some of the money used to finance the project will be debt. Given this fact, should the projected cash flows be revised to show projected interest charges? Explain. 2. Suppose you learned that Allied had spent 50,000 to renovate the building last year, expensing these costs. Should this cost be reflected in the analysis? Explain. 3. Suppose you learned that Allied could lease its building to another party and earn 25,000 per year. Should that fact be reflected in the analysis? If so, how? 4. Assume that the lemon juice project would take profitable sales away from Allied's fresh orange juice business. Should that fact be reflected in your analysis? If so, how? c. Disregard all the assumptions made in part b and assume there is no alternative use for the building over the next 4 years. Now calculate the project's NPV, IRR, MIRR, and payback. Do these indicators suggest that the project should be accepted? Explain. Allied's Lemon Juice Project (in Thousands) TABLE IC 12.1 TABLE IC 12.2 Allied's Lemon Juice Project Considering 5% Inflation (in Thousands) d. If this project had been a replacement rather than an expansion project, how would the analysis have changed? Think about the changes that would have to occur in the cash flow table. e. 1. What three levels, or types, of project risk are normally considered? 2. Which type is most relevant? 3. Which type is easiest to measure? 4. Are the three types of risk generally highly correlated? f. 1. What is sensitivity analysis? 2. How would you perform a sensitivity analysis on the unit sales, salvage value, and WACC for the project? Assume that each of these variables deviates from its base-case, or expected, value by plus or minus 10%, 20%, and 30%. Explain how you would calculate the NPV, IRR, MIRR, and payback for each ease; but don't do the analysis unless your instructor asks you to. 3. What is the primary weakness of sensitivity analysis? What are its primary advantages? Work out quantitative answers to the remaining questions only if your instructor asks you to. Also note that it will take a long time to do the calculations unless you are using an Excel model. g. Assume that inflation is expected to average 5% over the next 4 years and that this expectation is reflected in the WACC. Moreover, inflation is expected to increase revenues and variable costs by this same 5%. Does it appear that inflation has been dealt with properly in the initial analysis to this point? If not, what should be done and how would the required adjustment affect the decision? h. The expected cash flows, considering inflation (in thousands of dollars), are given in Table IC 12.2. Allied's WACC is 10%. Assume that you are confident about the estimates of all the variables that affect the cash flows except unit sales. If product acceptance is poor, sales would be only 75,000 units a year, while a strong consumer response would produce sales of 125,000 units. In either case, cash costs would still amount to 60% of revenues. You believe that there is a 25% chance of poor acceptance, a 25% chance of excellent acceptance, and a 50% chance of average acceptance (the base case). Provide numbers only if you are using a computer model. 1. What is the worst-case NPV? The best-case NPV? 2. Use the worst-case, most likely case (or base-case), and best-case NPVs with their probabilities of occurrence, to find the project's expected NPV, standard deviation, and coefficient of variation. i. Assume that Allied's average project has a coefficient of variation (CV) in the range of 1.25 to 1.75. Would the lemon juice project be classified as high risk, average risk, or low risk? What type of risk is being measured here? j. Based on common sense, how highly correlated do you think the project would be with the firm's other assets? (Give a correlation coefficient or range of coefficients, based on your judgment.) k. How would the correlation coefficient and the previously calculated combine to affect the project's contribution to corporate, or within-firm, risk? Explain. l. Based on your judgment, what do you think the project's correlation coefficient would be with respect to the general economy and thus with returns on the market? How would correlation with the economy affect the project's market risk? m. Allied typically adds or subtracts 3% to its WACC to adjust for risk. After adjusting for risk, should the lemon juice project be accepted? Should any subjective risk factors be considered before the final decision is made? Explain. n. In recent months, Allieds group has begun to focus on real option analysis. 1. What is real option analysis? 2. What are some examples of projects with embedded real options?
Comprehensive Problem Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufacture and sell one of two new products for a five-year period. His annual pay raises are determined by his division’s return on investment (ROI), which has exceeded 18% each of the last three years. He has computed the cost and revenue estimates for each product as follows: The company’s discount rate is 16%. Required: 1. Calculate the payback period for each product. 2. Calculate the net present value for each product. 3. Calculate the internal rate of return for each product. 4. Calculate the project profitability index for each product. 5. Calculate the simple rate of return for each product. 6. Which of the two products should Lou’s division pursue? Why?
Part 3: Capital Budgeting and Project Evaluation Case Study: Assume that the company, where you are working as a team in Financial Department, is considering a potential project with a new product. It will require the company to buy a new equipment that will generate the same revenue for the company each year. The table below shows the initial and annual costs for each option. 3.1. Capital Budgeting Decision Making: Perform capital budgeting technique based on Equivalent Annual Cost (EAC) to advise the Company Management which option should be chosen if the relevant discount rate is 9%? Costs Option A Option B Initial Investment 1,400,000 1,500,000 Year 1 35,000 25,000 Year 2 35,000 25,000 Year 3 35,000 25,000 Year 4 35,000 25,000 Year 5 25,000 3.2. Risk Analysis and Project evaluation: Assume that the company finally chose Option B. It expects to sell 600,000 units of the new product for an average price of $15 per unit. The…
Part 3: Capital Budgeting and Project EvaluationCase Study: Assume that the company, where you are working as a team in Financial Department,is considering a potential project with a new product. It will require the company to buy a newequipment that will generate the same revenue for the company each year. The table below showsthe initial and annual costs for each option.3.1. Capital Budgeting Decision Making: Perform capital budgeting technique based on EquivalentAnnual Cost (EAC) to advise the Company Management which option should be chosen if therelevant discount rate is 9%?Costs Option A Option BInitial Investment 1,400,000 1,500,000Year 1 35,000 25,000Year 2 35,000 25,000Year 3 35,000 25,000Year 4 35,000 25,000Year 5 25,000
Question 2Swann Systems is forecasting the following income statement for the upcoming year:Sales $5,000,000Operating costs (excluding depreciation) $3,000,000Gross margin $2,000,000Depreciation $500,000EBIT $1,500,000Interest $500,000EBT $1,000,000Taxes (40%) 400,000Net income $ 600,000The company’s president is disappointed with the forecast and would like to see Swann generate higher sales and a forecasted net income of $2,000,000. Assume that operating costs (excluding depreciation) are always 60 percent of sales. Also, assume that depreciation, interest expense, and the company’s tax rate, which is 40 percent, will remain the same even if sales change. What level of sales would Swann have to obtain to generate $2,000,000 in net income?Show your calculations. Question 3 Please review the two PPT packages below, and then prepare an essay (or memo) that includes the following elements. Limit to 2-4 pages (including charts / tables / references where applicable).What is the key theme…
Solve Part 3.2 please Part 3: Capital Budgeting and Project EvaluationCase Study: Assume that the company, where you are working as a team in Financial Department,is considering a potential project with a new product. It will require the company to buy a newequipment that will generate the same revenue for the company each year. The table below showsthe initial and annual costs for each option.3.1. Capital Budgeting Decision Making: Perform capital budgeting technique based on EquivalentAnnual Cost (EAC) to advise the Company Management which option should be chosen if therelevant discount rate is 9%?Costs Option A Option BInitial Investment 1,400,000 1,500,000Year 1 35,000 25,000Year 2 35,000 25,000Year 3 35,000 25,000Year 4 35,000 25,000Year 5 25,0003.2. Risk Analysis and Project evaluation:Assume that the company finally chose Option B. It expects to sell 600,000 units of the new productfor an average price of $15 per unit. The Equipment in Option B has a residual value of $300…
3. Analysis of an expansion project Companies invest in expansion projects with the expectation of increasing the earnings of its business. Consider the case of Lumbering Ox Truckmakers: Lumbering Ox Truckmakers is considering an investment that will have the following sales, variable costs, and fixed operating costs: Year 1 Year 2 Year 3 Year 4 Unit sales (units) 4,200 4,100 4,300 4,400 Sales price $29.82 $30.00 $30.31 $33.19 Variable cost per unit $12.15 $13.45 $14.02 $14.55 Fixed operating costs except depreciation $41,000 $41,670 $41,890 $40,100 Accelerated depreciation rate 33% 45% 15% 7% This project will require an investment of $10,000 in new equipment. The equipment will have no salvage value at the end of the project’s four-year life. Lumbering Ox Truckmakers pays a constant tax rate of 40%, and it has a required rate of return of 11%. When using accelerated depreciation, the project’s net present value (NPV) is .…
3. Analysis of an expansion project Companies invest in expansion projects with the expectation of increasing the earnings of its business. Consider the case of McFann Co.: McFann Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs: Year 1 Year 2 Year 3 Year 4 Unit sales 4,800 5,100 5,000 5,120 Sales price $22.33 $23.45 $23.85 $24.45 Variable cost per unit $9.45 $10.85 $11.95 $12.00 Fixed operating costs $32,500 $33,450 $34,950 $34,875 This project will require an investment of $25,000 in new equipment. Under the new tax law, the equipment is eligible for 100% bonus deprecation at t = 0, so it will be fully depreciated at the time of purchase. The equipment will have no salvage value at the end of the project’s four-year life. McFann pays a constant tax rate of 25%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project’s net present value (NPV) would be…
QUESTION 25 Top management is trying to determine which would be the best choice of the following: Data of investment choices: 1 Sales $10,000,000 Operating income        200,000 Average operating assets    2,000,000 Required: Compute the Return on Investment 9% 12% 8% 10%
QUESTION 27 Top management is trying to determine which would be the best choice of the following   investment opportunities: Data of investment choices: 2 Sales $9,000,000 Operating income      300,000 Average operating assets 3,000,000 Required: Compute the Return on investment 8% 10% 12% 9%
Question 3) Textbook Exercise 13-29: Cost-plus operating income/return on investment pricing. 13-29 Cost-plus, target return on investment pricing. Zoom-o-licious makes candy bars for vending machines and sells them to vendors in cases of 30 bars. Although Zoom-o-licious makes a variety of candy, the cost differences are insignificant, and the cases all sell for the same price. Zoom-o-licious has a total capital investment of $15,000,000. It expects to produce and sell 300,000 cases of candy next year. Zoom-o-licious requires a 10% target return on investment. Expected costs for next year are: Variable production costs $4.00 per case Variable marketing and distribution costs $1.00 per case Fixed production costs           $300,000 Fixed marketing and distribution costs           $400,000 Other fixed costs           $200,000 Zoom-o-licious prices the cases of candy at full cost plus markup to generate profits equal to the target return on capital.…