MUNTILOLIUI UI UM Project unrelated to current operations Research and development operations Determine each project's risk-adjusted net present value. Mini Case This Mini Case is available in MyFinanceLab. It's been 2 months since you took a position as an assistant financial analyst at Caledonia Products. Although your boss has been pleased with your work, he is still a bit hesitant about unleashing you without supervision. Your next assignment in- volves both the calculation of the cash flows associated with a new investment under consideration and the evaluation of several mutually exclusive projects. Given your lack of tenure at Caledonia, you have been asked not only to provide a recommenda- tion but also to respond to a number of questions aimed at judging your understand- ing of the capital-budgeting process. The memorandum you received outlining your assignment follows: To: The Assistant Financial Analyst From: Mr. V. Morrison, CEO, Caledonia Products Re: Cash Flow Analysis and Capital Rationing CHAPTER 11 Cash Flows and Other Topics in Capital Budgeting We are considering percent man of capital. This what of a fad new project: considering the introduction of a new product. Currently we are in the marginal tax bracket with a 15 percent required rate of return or cost This project is expected to last 5 years and then, because this is some- fad product, be terminated. The following information describes the cost of new plant and equipment giging and installation costs $7.900.000 $ 100.000 NT SALES YEAR UNITS SOLD 70,000 120,000 140,000 80,000 60,000 Sales price per unit Tariable cost per unit Innual fixed costs Working-capital requirements $300/unit in years I though 4 $200 $180/unit $200,000 per year in years 1-5 There will be an initial working capital requirement of $100.000 just to get production started. For each year, the total investment in net working capital will be equal to 10 percent of the dollar value of sales for that year. Thus, the investment in working capi- tal will increase during years I through 3, then decrease in year 4 Finally, all working capital is liquidated at the termination of the project at the end of year 5. Use the simplified straight-line method over 5 years. Assume that the plant and equipment will have no salvare value after 5 years. Depreciation method a. Should Caledonia focus on cash flows or accounting profits in making its capital-budgeting decisions? Should the company be interested in incremental cash flows, incremental profits, total free cash flows, or total profits? b. How does depreciation affect free cash flows? C. How do sunk costs affect the determination of cash flows? d. What is the project's initial outlay? e What are the differential cash flows over the project's life? 1. What is the terminal cash flow? 8 Draw a cash flow diagram for this project. h. What is its net present value? What is its internal rate of return? Mould the project be accepted? Why or why not? capital budgeting, risk can be measured from three perspectives. What are ose three measures of a project's risk k In capital buio 1. According to What complic Ording to the CAPM, which measurement of a project's risk is relevant? at complications does reality introduce into the CAPM view of risk, and t does that mean for our view of the relevant measure of a project's what does that mea risk? m. Explain how approach? n. What is sensitiv Main how simulation works. What is the value in using a simulation is sensitivity analysis, and what is its purpose