Waqa Ltd is a manufacturer of cutlery. The firms managers have asked you to evaluate a project proposal to diversify into manufacturing nailfiles. A new machine to mould the plastic on to the end of the nailfiles would need to be purchased at a cost of $150 000. Freight and insurance for the new machine will cost $3500 and installation will cost a further $1200. The files would be pressed on existing equipment. The files would be produced by introducing a night shift, so will not displace any current production capacity. The existing machine would be modified at a cost of $20 000.

If the new project goes ahead, Waqa will need to increase the raw materials inventory by $2500. The finished goods inventory would need to be $4500 higher than its current level. Waqa will supply 30-day terms to the distributors of the nailfiles and this is expected to result in an increase of $60 000 in accounts receivable. The increase in accounts receivable will occur during the first week of production for the project. Waqa has arranged credit with suppliers of the plastic that will be used in the production process. This is expected to result in an increase of $15 000 to accounts payable.

(a) What is the installed cost of the project?

(b) What is the change in net working capital?

(c) What is the initial outlay for the nailfile project?

Part 2

Waqa Ltd have set a 5-year life for the proposed nailfile project. Waqas management have given you the following forecasts of operating cash flows:

• Sales of nailfiles for the first year are $120 000. The estimated growth rate for sales is 2% p.a. for the second and subsequent years of the project.
• Raw materials are estimated at 15% of sales.
• Labour costs for the project will be $30 000 per annum.
• Waqas annual electricity bill is $50 000. The electricity cost for the nailfile project is expected to be 12% of sales.
• Determine the annual net operating cash flow for the nailfile project.

Part 3

At the end of 5 years, Waqa will terminate the nailfile project. It is expected that the plastic moulding machine that was purchased for the project will be sold for $30 000. Removal costs of $650 are expected for the moulding machine. The modifications to the machine used for pressing the metal part of the files will not affect the future use of that machine and will remain in place. The increase in net working capital (see problem 8.1) will be returned to the firm at the end of the project. What is the terminal value of the nailfile project?

Part 4

Using your calculations in from Part 1 to Part 3:

(a) Construct a table of the annual cash flows for Waqas nailfile project.

(b) Calculate the NPV of the project using a discount rate of 10%.

(c) On the basis of the NPV, is the project acceptable? Why?

(d) Calculate the IRR of the project and compare it to a hurdle rate of 10%.

(e) On the basis of the IRR, is the project acceptable? Why?