Managerial Finance Cost Capital

**Adams, Incorporated would like to add a new line of business to its existing retail**

**business. The new line of business will be the manufacturing and distribution of animal**

**feeds. This is a major capital project. Adams, Incorporated is aware you an in an MBA**

**program and would like you to help analysis the viability of this major business venture**

**based on the following information:**

**The production line would be set up in an empty lot the company owns.**

**The machinery’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 useful life of 4 years, and it is a MACRS 3-year asset.**

**The machinery is expected to have a salvage value of $25,000 after 4 years of**

**use.**

**This new line of business will 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.**

**Net working capital would have to increase by an amount equal to 12% of sales**

**revenues. The firm’s tax rate is 40%, and its overall weighted average cost of**

**capital is 10%.**

**Required:**

**1. If the company spent $40,000 last year in the upkeep of the empty lot, should this**

**cost be included in the analysis? Why or why not?**

**2. Disregard the assumptions in part 1 above. What is the machinery’s depreciable**

**basis? What are the annual depreciation expenses?**

**3. Calculate the annual sales revenues and costs (other than depreciation).**

**4. Construct annual incremental operating cash flow statements.**

**5. Estimate the required net working capital for each year based on sales for the**

**following year. Working capital will be recovered at the end of year 4.**

**6. Calculate the after-tax salvage cash flow.**

**7. Calculate the net cash flows for each year. Based on these cash flows, what are**

**the project’s NPV, IRR, Profitability Index (PI), and payback?**

**8. Can you use the Payback method to decide whether this is a good project or**

**not? Why or why not?**

**9. Interpret what NPV, IRR, and Profitability Index (PI) mean. Based on your**

**interpretation, do these indicators suggest the new business line should be**

**undertaken?**