Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Background: Stockbridge Sprockets, Inc. ( SSI or the Company ) wants to bring an improved line of sprockets to the market. While their current sprocket

Background:
Stockbridge Sprockets, Inc. (SSI or the Company) wants to bring an improved line of sprockets to the market. While their current sprocket machine can produce the new product, the Company wants to determine if it will be more cost effective to invest in a new machine that can produce the new product line more efficiently. They have hired you to do a financial analysis and make a recommendation as to whether they should purchase the new machine.
The Company has determined that their new product line will need to be upgraded in 5 years, so the project to determine whether to buy the new machine will have a 5 year time horizon.
Data:
SSI paid $100,000 for the factory that the new product will be made in. They made this purchase in 2016.
The Company spent $5,000 last year to secure the patent on the new line of sprockets.
The cost of the new machine will be $35,000. This will be depreciated straight-line to 0 over the machines estimated 7 year useful life.
The Company spent $2,500 on a trip to see a similar machine in use at a factory in Red Deer, Alberta last year.
If the Company buys the new machine, it will sell its current machine to Mid-Montana Manufacturing, Inc., who has already made SSI an offer of $7,594.94. The current machine has already been fully depreciated, and will be sold at the beginning of the project (Round the tax implication to 2 decimal places).
The efficiency of the new machine would allow more products to be produced each year, leading to additional revenue in year 1 in the amount of $34,000.
As word of the quality of the new product spreads in the marketplace, revenue will grow in Years 2 & 3 by 5.5% per year.
In Years 4 & 5, the market for the new product will become saturated, leading to a reduction in revenue by 4% per year.
Variable costs are estimated to be 72% of revenue.
Fixed production costs are estimated to be $2,750 per year.
Additional Net Working Capital will be required at the beginning of the project in the amount of $8,000.60% of this will be recovered in the projects terminal year.
At the end of the project, the company has estimated that it will be able to sell the machine it bought in Year 0 for $15,000.
The companys tax rate is 21%
The Required Rate of Return on the project is 10%.
Base Case:
Use the data above to construct the Base Case analysis. Calculate NPV and IRR.
Scenario Analysis:
After you complete the Base Case, copy and paste it to the Case 2 and Case 3 tabs.
SSI has hired a consultant to review their estimates and assumptions regarding the project. They believe the company is being a bit optimistic, and has created a worst case (Case 2) and best case (Case 3) scenario.
Alternate Scenario 1(Worst Case)
In this scenario, change Revenue Growth in Yrs.2 & 3 to 5.2%, Variable Costs as a % of Revenue to 72.5%, Year 1 Revenue to 33,000. Note the new NPV and IRR.
Alternate Scenario 2(Best Case)
In this scenario, change Revenue Growth in Yrs.2 & 3 to 5.9%, Variable Costs as a % of Revenue to 71.5%. Note the new NPV and IRR.
Recommendation
Based on the results from the 3 Cases, make a recommendation as to whether SSI should purchase the new machine or not. Hint: the correct method can be found in Ch.13.
The consultant has assigned the following probabilities of each scenario occurring:
Base Case: 50%
Case 2: 30%
Case 3: 20%
Question 1) What is the Base Case NPV?
Question 2) Based on your entire analysis, should the project be accepted or rejected?

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Public Finance A Contemporary Application Of Theory To Policy

Authors: David N Hyman

10th Edition

053875446X, 978-0538754460

More Books

Students also viewed these Finance questions

Question

Where do emotions come from? What function do they serve?

Answered: 1 week ago