The Base Case:

Mid-Michigan Manufacturing Inc. (MMMI) wishes to determine whether it would be advisable to replace an existing production system with a new automated one. They have hired your firm (your group) as a consultant to determine whether the new system should be purchased. The data you will need is as follows:

• MMMI has decided to set a project timeline of 5 years.

• The new system will cost $1,900,000. It will be depreciated (straight line) over a six-year period (its estimated useful life), assuming a salvage value of $100,000.

• The old system, which has been fully depreciated, could be sold today for $253,165. The company has received a firm offer for the system from Williamston Widgets, and MMMI will sell it only if they purchase the new system.

• Additional sales generated by the superior products made by the new system would be $1,500,000 in Year 1. In Years 2 and 3 sales are projected to grow by 5.5% per year. However, in Years 4 and 5, sales are expected to decline by 25% per year as the market starts to become saturated.

• Total expenses have been estimated at 67.4% of Sales.

• The firms tax rate 21%.

• MMMI requires a minimum return on the replacement decision of 9.5%.

• A representative from Stockbridge Sprockets has told MMMI that they will buy the system from them at the end of the project (the end of Year 5) for $200,000. MMMI has decided to include this in the terminal value of the project.

• The project will require $150,000 in additional Net Working Capital, 67% of which will be recovered at the end of the project.

In this case :

Reverting back to the Base Case estimates and assumptions, now assume that sales growth in Years 2 and 3 will be 5.3% each year instead of 5.5%, and that sales in Years 4 and 5 will decline by 27.5% per year rather than 25% (all other estimates remain the same). Recalculate NPV and IRR, and somewhere on the Part 3 sheet state whether you would accept or reject the project based on this scenario alone. Note: this scenario has a 10% chance of occurring.

My question is whether i would accept or reject the project based on this scenario alone.

VALUE DRIVERS Sales Growth yrs 2-3 Sales Growth yr 4 Sales Growth yr 5 Expenses as a % of sales Cost of the new system Salvage Value of new system Old sysytem resale New System resale in yr 5 Tax rate Required Rate of Return Project Time Period 5.5% -25.0% -25.0% 67.40% $1,900,000 $100,000 $253,165 $200,000 21.00% 9.50% 5 Years 0 $1,700,000 1 2 3 4 5 $158,000 Capital Spending OCF: Revenues Expenses Depreciation EBIT Taxes Net Income Depreciation OPERATING CASH FLOW $1,500,000 $1,582,500 $1,669,538 $1,252,153 $939,115 $1,011,000 $1,066,605 $1,125,268 $843,951 $632,963 $316,667 $633,333 $950,000 $1,266,667 $1,583,333 $172,333 -$117,438 -$405,731 -$858,465 -$1,277,182 $36,190 $24,662 $85,203 $180,278 $268,208 $136,143 $92,776 $320,527 $678,187 $1,008,974 $0 $316,667 $633,333 $950,000 $1,266,667 $1,583,333 $452,810 $540,557 $629,473 $588,480 $574,360 Net Working Capital $150,000 $79,395 Total Cash Flow $1,850,000 $452,810 $540,557 $629,473 $588,480 $811,755 NPV IRR 418,776.50 17.20% VALUE DRIVERS Sales Growth yrs 2-3 Sales Growth yr 4 Sales Growth yr 5 Expenses as a % of sales Cost of the new system Salvage Value of new system Old sysytem resale New System resale in yr 5 Tax rate Required Rate of Return Project Time Period 5.3% -27.0% -27.0% 67.40% $1,900,000 $100,000 $253,165 $200,000 21.00% 9.50% 5 Years 1 2 3 4 5 $158,000 Capital Spending $1,700,000 OCF: Revenues Expenses Depreciation EBIT Taxes Net Income Depreciation OPERATING CASH FLOW $1,500,000 $1,579,500 $1,663,214 $1,214,146 $886,326 $1,011,000 $1,064,583 $1,121,006 $818,334 $597,384 $316,667 $633,333 $950,000 $1,266,667 $1,583,333 $172,333 $118,416 $407,792 $870,855 -$1,294,391 $36,190 $24,867 $85,636 $182,880 $271,822 $136,143 $93,549 $322,156 $687,976 $1,022,569 $0 $316,667 $633,333 $950,000 $1,266,667 $1,583,333 $452,810 $539,784 $627,844 $578,691 $560,765 Net Working Capital $150,000 $79,395 Total Cash Flow -$1,850,000 $452,810 $539,784 $627,844 $578,691 $798,160 NPV 401,447.08 16.92% IRR