Question #1 - Capital Budgeting

Christian Co. makes and sells winter boots.They have hired you to evaluate information gathered regarding two potential long-term investments.They have provided you with information gathered about each option below.Evaluate the information, determine what is relevant, then use excel to calculate an NPV for each option.Based on the information and calculation, determine which of the investments Christian should pursue. Christian's tax rate is 30%.A consultant was hired to gather information about both options.She was paid $150,000 and spent 60% of her time on option 2 and 40% on option 1.

Option #1:Purchase a new machine which can increase capacity for making existing winter boots to fill unmet demand.CCA for this machine is expected to be 25%

By purchasing this machine Christian expects they can make and sell an additional 200,000 pairs of boots per year.The boots have historically been very popular and Christian believes this demand will continue to increase for at least four more years.After the four years, it is expected this machine will be sold or traded in for a newer machine that will offer new technologies for boot manufacturing.Additional information can be found below:

1.The sell price of boots is $250 with variable cost at 75% of revenue.

2.Maintenance on the machine is expected to be $40,000 per year in the first two years and $30,000 per year in the remaining years.

3.The initial purchase of the machine is expected to be $40,000,000 and it will depreciate using straight-line over four years.The salvage of the machine after four years is expected to be $5,000,000.

4.Working capital required is expected to be $250,000 all recovered by the end of four years.

5.The discount rate deemed appropriate to review this project is 8%.

6.Promotion expenses are expected to increase by $30,000 per year in years one and two and then go down to $20,000 per year after that to ensure the demand for the boots will be strong.

Option #2:Purchase a new building in Mexico to manufacture a new line of winter boots.The life of this project is expected to be seven years.The CCA rate for the building and equipment will be 20%

1.The new boots will sell for $150 with variable cost at 45% of revenue.

2.Demand for the new boots is not certain, but the consultant expects that the market will be 300,000 per year.The sales of the existing winter boot is expected to decline by 5000 boots per year if the new boot is available.

3.The initial investment of building and equipment is expected to total $120M.The building will depreciate at 15% per year and the equipment at 20% per year both using straight line.

4.The building and equipment are expected to sell for $55M at the end of seven years.

5.Promotion expenses are expected to be $100,000 per year for the first four years and $75,000 per year after that

6.Maintenance is expected to be $15,000 per year

7.Working capital investment will be $150,000 all recovered in the final year of the project

8.The discount rate deemed appropriate to review this project is 12%

Question #1-Continued

Required:

1.Using excel, calculate the NPV of both options

2.Explain why you included (or not) each component of the NPV calculation.

3.Compare and contrast the risk associated to each project.

4.Which of the projects would you recommend?Why or Why not?