Shrieves Casting Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by Sidney Johnson, a recently graduated MBA. The production line would be set up in unused space in Shrieves main plant. The machinery would incur $10,000 in shipping charges, and it would cost an additional $28,000 to install the equipment. The machinery has an economic life of 4 years, and Shrieves has obtained a special tax ruling that places the equipment in the MACRS 3year class. The machinery is expected to have a salvage value of 15% of initial outlay after 4 years of use.

The new line would generate incremental unit sales per year for 4 years at an incremental cost of $108 per unit in the first year, excluding depreciation. Each unit can be sold for $200 in the first year. The sales price and cost are both expected to increase by 3% per year due to inflation. Further, to handle the new line, the firms net working capital would have to increase by an amount equal to 12% of sales revenues. The firms tax rate is 35%, and its overall weighted average cost of capital is 10%.

Invoice price	225,000
Unit sales	1,300
Poor acceptance	950
Strong acceptance	1,700

A. What is Shrieves depreciable basis? What are the annual depreciation expenses?

B. Calculate the annual sales revenues and costs (other than depreciation). Why is it important to include inflation when estimating cash flows?

C. Construct annual incremental operating cashflow statements.

D. Estimate the required net working capital for each year and the cash flow due to investments in net working capital.

E. Calculate the aftertax salvage cash flow.

F. Calculate the net cash flows for each year. Based on these cash flows, what are the projects NPV, IRR, MIRR, PI, payback, and discounted payback? Do these indicators suggest that the project should be undertaken?

G. What does the term risk mean in the context of capital budgeting; to what extent can risk be quantified; and, when risk is quantified, is the quantification based primarily on statistical analysis of historical data or on subjective, judgmental estimates?

H. What are the three types of risk that are relevant in capital budgeting?

I. How is each of these risk types measured, and how do they relate to one another?

J. How is each type of risk used in the capital budgeting process?

K. Perform a sensitivity analysis on the unit sales, salvage value, and cost of capital for the project. Assume each of these variables can vary from its basecase, or expected, value by +/-10%, +/-20%, and +/-30%.

Include a sensitivity diagram, and discuss the results.

L. Assume that Sidney Johnson is confident in her estimates of all the variables that affect the projects cash flows except unit sales and sales price. If product acceptance is poor, unit sales would be as in the table and the unit price would only be $160; a strong consumer response would produce sales as in the table and a unit price of $240. Johnson believes there is a 25% chance of poor acceptance, a 25% chance of excellent acceptance, and a 50% chance of average acceptance (the base case).

M. What is the worstcase NPV? The bestcase NPV?

N. Use the worst, base, and bestcase NPVs and probabilities of occurrence to find the projects expected NPV, as well as the NPVs standard deviation and coefficient of variation.

O. Shrieves typically adds or subtracts 3 percent age points to the overall cost of capital to ad just for risk. Should the new line be accepted?

PLEASE SHOW ALL WORK AND GRAPH WHEN NEEDED!