The Capital Investment Decision You are hired to replace the assistant manager who had prepared the companys capital investment for its Aerospace. Your boss comes into your office and drops the report of capital investment that was prepared by the assistant manager. You open the report, and you find out the following estimates: Equipment cost $45,000 Sales $40,000 Cost of goods sold $30,000 Gross profit $10,000 General, S&A $3,000 Depreciation $7,500 Net operating income -$500 Income tax $125 Net income -$375 You noticed the depreciation is estimated using a straight line and you wonder if maybe MACRS would have been better. The report also indicates that the project is not profitable since its net income is negative. You think back to your finance classes and realize the mistakes that are made in this report. The Capps Industrial Supply is a private company, but the issues discussed in this case is not factual, however, the company might face them in its future operation. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means electronic, mechanical, photocopying, recording, or otherwisewithout the permission of the author. First, you note that the assistant manager did not factor in that the project will require a $10,000 investment in the net working capital upfront (year 0), which will be fully recovered at the end of 6 years. Next, you see they have attributed $3,000 of selling, general, and administrative expenses to the project, but you know that $1,000 of this amount is overhead that will be incurred even if the project is not accepted. Finally, you know that accounting earnings are not the right thing to focus on! Capps Supply is a private unlevered company. The company does not know its cost of capital and as result, you need to come up with the cost of capital to evaluate the project. You also remember in your finance classes that you could estimate the cost of capital by using the security market line (SML). To calculate the SML you need to have the beta, risk-free rate, and market risk premium. You check the internet, and you find out the 30-years treasury bond rate is about 3% and the market risk premium is 8 percent. 1. Given the available information, what are the free cash flows in years 0 through 6 that should be used to evaluate the proposed project? 2. What is the cost of capital? 3. What is the NPV? 4. Should the company accept your calculations and invest.? Aerospace & Defense Name Symbol Market Capitalization Current Price Beta Debt to Capital AAR Corp. AIR $1.5B $41.34 1.5 9.00% Aerojet Rocketdyne Holdings Inc AJRD $3.5B $42.93 0.5 44.00% AeroVironment, Inc. AVAV $2.0B $81.21 0.5 24.00% Boeing Co BA $93.6B $158.16 1.4 130.00% BWX Technologies Inc BWXT $5.0B $54.77 0.8 66.00% Cae Inc (USA) CAE $10.5B $25.63 1.9 44.00% Curtiss-Wright Corp. CW $5.3B $136.72 1.3 39.00% Embraer SA (ADR) ERJ $1.6B $8.66 1.2 57.00% Elbit Systems Ltd ESLT $9.9B $223.65 0.7 30.00% General Dynamics Corporation GD $60.2B $216.76 0.9 40.00% Heico Corp HEI $7.8B $143.20 1.1 20.00% HEICO CORP HEI.A $9.4B $115.12 1.1 17.00% Huntington Ingalls Industries Inc HII $8.4B $208.73 0.7 55.00% Howmet Aerospace Inc HWM $14.4B $34.36 1.6 55.03% Hexcel Corporation HXL $4.8B $57.11 1.2 37.00% Kratos Defense & Security Solutions, Inc KTOS $1.8B $14.31 0.8 45.00% This case is prepared by Dr. J. Kash Kashefi as a basis for class discussion rather to illustrate effective or ineffective handling of an administrative situation. The Capps Industrial Supply is a private company, but the issues discussed in this case is not factual, however, the company might face them in its future operation. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means electronic, mechanical, photocopying, recording, or otherwisewithout the permission of the author. L3Harris Technologies Inc LHX $43.4B $225.13 0.7 35.00% Lockheed Martin Corporation LMT $104.7B $394.74 0.7 50.46% Maxar Technologies Inc MAXR $1.9B $26.01 1.3 60.00% Moog Inc MOG.A $2.3B $80.00 1.3 37.00% Mercury Systems Inc MRCY $3.5B $61.31 0.8 24.00% Northrop Grumman Corporation NOC $70.2B $451.85 0.6 50.00% Raytheon Technologies Corp RTX $140.1B $94.21 1.2 29.83% Rolls-Royce Holding PLC (ADR) RYCEY $9.7B $1.16 1.1 45.00% Virgin Galactic Holdings Inc SPCE $1.9B $7.32 0.7 55.00% Spirit AeroSystems Holdings, Inc. SPR $3.6B $33.86 1.7 95.00% TransDigm Group Incorporated TDG $31.7B $581.12 1.4 142.00% Textron Inc. TXT $13.7B $63.83 1.6 35.00%