CAPITAL BUDGETING

Use an Excel spreadsheet to present the solution to the following four questions:

The Carberware Corporation is considering a project to produce a new line of microwave ovens to replace an older line in order to meet an expected growth in market demand for new styles of ovens. In order to produce the new microwaves, the company needs to replace an existing old assembly line that produces an older style with the new one. The new line costs $2,700,000 (plus $300,000 in shipping and installation). The old line has been fully depreciated and the new one would be depreciated on a straight-line basis over its estimated useful life of 12 years. If the decision is made to go ahead with the project the old line can be sold to another smaller company for $460,000. Annual revenues are expected to be $2,480,000; cost of goods sold $740,000; operating costs (excluding depreciation) $640,000. The company would need to set aside $350,000 as an estimated cost of training a crew to operate the new line. Also, the size of the new equipment would require that the it be housed in a nearby storage facility the company has purchased some time ago for $250,000 and that now is estimated to have a market value of $400,000. The company estimates the actual productive life of the project at nine years, after which the new machine would be sold for a salvage value of $1,150,000. The existing operating profit (EBIT) from the old line is $120,000 per year (which is assumed to continue for the following nine years if the new project does not get the green light). The initial net working capital needed for the expanded operations is estimated at $480,000. The NWC will rise to $620,000 by the end of year one, then to $920,000 by the end of year two. No additional changes in NWC are expected for years three through six. By the end of year seven, the NWC would be reduced to $520,000, then to $240,000 in year eight before it is completely recovered by the end of year none (no theft, spoilage, or obsolescence is assumed to have occurred). The way the company made all these estimates is by conducting a technical and economic feasibility study that cost $120,000. It also cost $86,000 to market-test a prototype of the new microwaves. The companys marginal tax rate is 25%. The required rate of return on this investment (aka cost of capital) is 12%.

1. Calculate the net initial cash outflow associated with acquisition of the new peg machine.
2. Calculate the expected after-tax salvage value of the new machine at the end of year nine.
3. Estimate all the relevant annual free cash flows and show them on a timeline using the Excel spreadsheet.
4. Use the six capital budgeting decision criteria to decide whether to go ahead with the project. Use the Excel finance functions. Assume a 7-year acceptable payback period.