Question
Fact Situation : You are the CFO of ABC Manufacturing Company. Your Company is considering the purchase of a machine which will automate its production
Fact Situation: You are the CFO of ABC Manufacturing Company. Your Company is considering the purchase of a machine which will automate its production process. You have been asked by the President to justify the purchase of the machine, and you have worked with the sales and manufacturing departments to develop projections relating to the purchase of the machine.
Here are the projections that your team has developed:
- The initial cost of the machine is $500,000
- The company uses straight line depreciation for a period of 5 years for machine of this type
- The company estimates the life of the project and cash flows to be 5 years
- The company expects incremental operating income to be $125,000 per year and a tax rate of 25%
- The companys weighted average cost of capital is 10.5%
- The company has traditionally used the simple payback method to evaluate project acceptance
You have completed the analysis of the machine, but are concerned that the cost of the machine and a number of other assumptions might change. Accordingly, you have performed a series of sensitivity analyses which have different assumptions for some of the items.
The changed assumptions are as follows:
- The cost of the machine changes to $550,000
- Incremental Operating income is reduced to $100,000 per year for five years
- The tax rate increases to 35%
Required: Complete a separate NPV worksheet for each of the changed assumptions. Only change one assumption (i.e. $550,000 for the machine) at a time and leave the other original assumptions constant. After updating the spreadsheet for each changed assumption, complete a sensitivity analysis table which includes the original spreadsheet calculations for NPV and IRR and the NPV and IRR for the three new scenarios. Make a revised recommendation about whether or not the project should be approved, and how each of the sensitivity scenarios might influence project acceptance. Determine which of the changed assumptions results in a greater impact to the project.
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