AGOURA MANUFACTURING MINI-CASE

Agoura Manufacturing has announced the introduction of a new product. They forecast product-specific sales demand to last five years. Then because this product is somewhat of a fad, they will terminate the project. Manufacturing of the product will require the acquisition of an existing facility and purchase and installation of some new equipment. The following information describes the new project:

Capital Investment requirement:

Cost of new plant and equipment: $13,750,000

Shipping and installation costs: $ 465,000

Working Capital requirements:

An initial working-capital requirement of $350,000 will accompany the start of production. After that, total investment in net working capital during each year will be equal to 16 percent of the dollar value of sales for that year. Therefore, the working capital investment required will increase during years 1 through 3, decrease in year 4, and finally, all working capital is converted to cash at the termination of the project at the end of year 5.

Sales Forecast:

Year

Units Sold

1

75,000

2

115,000

3

195,000

4

75,000

5

45,000

Sales price per unit: $275/unit in years 1-4, $180/unit in year 5

Variable cost per unit: $215/unit

Annual fixed costs: $675,000

Other Assumptions:

Agoura Manufacturing uses the simplified straight-line depreciation method over useful life. The plant and equipment will have no salvage value after five years. Agoura Manufacturing pays taxes at a 34% marginal rate. Their cost of capital is 17%, and this project offers a similar risk profile to the company's overall operations.

Questions:

1. With respect to the decision to buy, which is more important for Agoura to consider, accounting profits earned or project free cash flows?

2. What is the effect of sunk costs and of depreciation on the determination of cash flows?

3. Determine the incremental cash flows Agoura could expect from the project in each year 1 to 5. How do these cash flows differ from accounting profits or earnings?

4. Calculate Agoura's initial outlay. Calculate the terminal cash flow.

5. Include a cash flow diagram for this project in your paper.

6. Calculate the project's net present value.

7. Calculate its internal rate of return.

8. Should Agoura accept the project? Explain your reasoning