Ma & Pa Incorporated manufactures toys for children and has partnerships with local retailers in the Midwestern states of Wisconsin, Iowa, Minnesota, and Illinois who sell their toys. The demand for children’s toys has increased steadily over the past decade; to cope with the increased demand, Ma & Pa Incorporated is considering opening another manufacturing plant. They currently have only one manufacturing plant in Wauwatosa, Wisconsin. The new location is anticipated to be in either Wisconsin or Illinois. As the company has steadily grown, Ma & Pa Incorporated has started paying higher taxes. The corporation is currently in the 35% tax bracket.

Constructing a new manufacturing plant could be a financially risky proposition if the revenue and expenses are not correctly accounted for. Andre Russell is charged with the task of deciding whether the project is worthwhile to undertake from a financial standpoint. Andre has extensive experience in capital budgeting techniques from his studies, but never had to use them for the company that his mom and dad built until now. He wants to do his best to apply capital budgeting and figure out the project’s feasibility from a financial standpoint.

Andre Russell understood that he needs to come up with estimates for the following: up-front cost, cost of capital, sales, cash expenses, and depreciation. Each of these is described in detail below in the document that he sends to you. Be sure to review it before moving forward.

You are working for Andre Russell in the finance department. Andre gave the numbers in the above document to you and mentioned that the project is expected to last eight years. He also asked you to use the expense estimates with the information in the following worksheet to prepare a report about whether the project should be accepted. He would also like you to speculate about how the proposed project might change based on six- and ten-year plans.

Ma & Pa Incorporated Expense Estimates (FIN_300)

The data below is based on Andre’s original request of examination of an eight year project. You will use these numbers to answer a. thru e. on the Ma & Pa Worksheet.

I. Up-front costs: Andre Russell worked with the top management (Bill, Lucy, Lilian, and Hillary) as well as selected middle manager to arrive at the up-front costs. Based on his discussions with them, he is anticipating the up-front costs to be comprised of the following:

· Cost of the land: He anticipates that the land will cost about $40,000 per acre and he needs about 5 acres ($200,000 in total).
· Cost of the building: $1,000,000
· Equipment: $250,000
· Furniture: $200,000
· IT infrastructure: $550,000
· Total projected up-front costs: $2,200,000

II. Cost of capital: Andre researched extensively on cost of capital and found:
· Total projected cost of capital: $195,000

III. Sales: After working with Elizabeth Brown, Director of Sales and Marketing, and several other managers in her area, Andre is projecting the following sales for the first year. Further, these sales are expected to grow at 10% compounded for the duration of the project.
· Electronic toys for children: $175,000
· Halloween toys: $320,000
· Christmas toys: $430,000
· Total projected sales: $925,000

IV. Cash expenses: Based on the past expenses and projections for future expenses, Andre arrived at the following expenses on an annual basis. For simplicity, Andre assumed that these expenses will grow at 2% annually for the duration of the project.
· Labor/Employment Expenses: $87,500
· Maintenance: $77,500
· New equipment: $75,000
· IT budget: $70,000
· Total projected cash expense: $310,000

V. Depreciation: Andre is expecting that the depreciation will computed as follows:
· Land value depreciation: $70,000
· Building value depreciation: $65,000
· Equipment depreciation: $60,000
· IT infrastructure depreciation $55,000
· Total projected depreciation: $250,000

Use the eight year model, along with Russel’s estimates for questions a. thru e.
a. At the end of the project, what is Ma & Pa Incorporated’s earnings before taxes then?
__________. At the current tax rate for Ma & Pa incorporated, what is Ma & Pa Incorporated’s net income?
b. Compute the project’s after-tax cash flow.
Operating cash flow = (Sales – Costs – Depreciation) (1 – t) + Depreciation – change in net working capital
c. Compute and interpret the project’s NPV, IRR, and profitability index.
d. According to your above calculations: What is your interpretation on if the project should be accepted or rejected?
e. The minimum required rate of return is a weighted average of the firm’s costs of various sources of capital. Explain.
f. Ma & Pa Incorporated realize that the project depreciation needs to be $290,000 and the project needs to last 10 years. The depreciation is now computed as follows:
· Land value depreciation: 80,000
· Building value depreciation: 75,000
· Equipment depreciation: 70,000
· IT infrastructure depreciation 65,000
Please compute the new NPV, IRR, and profitability index using the new numbers.
g. Assume that they reduced the expenses, but depreciation increased to 350,000 and the project duration decreased to 6 years.
· Land value depreciation: 100,000
· Building value depreciation: 90,000
· Equipment depreciation: 85,000
· IT infrastructure depreciation 75,000
Please compute the new NPV, IRR, and profitability index using the new numbers.

h. Regarding firm’s decision strategies: Between the original eight year scenario, and the scenarios from f and g (six and 10 year scenarios) - identify which is the best scenario.
Please justify your choice using IRR, NPV and PI.