WWW will invest considerable amounts into expanding their current widget production capacity This will involve the construction of a large extension to their existing factory, as well as the purchase of new production equipment, the training of new production workers, and the operation of this new capacity across the next 20 years Project A Costs and Cashflow Elements Money Out The construction of the new factory extension will cost an estimated $8 7 million and will take place in years 1 and 2, with total costs spread evenly across both years The new equipment needed to expand production will cost an estimated $6 1 million, which will occur in year 2 Training for new staff will cost a projected $645,000 in year 2 Maintenance on the building and new equipment will cost an estimated $300,000 annually, beginning at the end of year 2, but is forecast to rise by $12,000 each year for the next 18 years, from year 2 to year 20 Current non operating costs and revenues are expected to remain unchanged and can be ignored Project A Costs and Cashflow Elements Money In WWW currently produces 25,000 widgets annually, at an Average Total Cost (ATC) per widget of $652 and a market price of $840 per widget WWW is a price searcher, so they have been holding production to the level at which they get the lowest ATC The marketing department is convinced that there would be much larger demand if they could lower the price to $680, but current costs prevent that Current sales are at 25,000 widgets per year Figure 1 shows the projected ATC curve for WWW if they go ahead with Project A Figure 2 shows the demand curve for Widgets in the current market Project B WWW has an opportunity to buy a nearby competitor Amazing Widgets Inc (AW) who currently produces a widget very similar to WWWs product The deal would be an outright purchase of the company, with all its current equipment, facilities, employees, assets and liabilities, and customer accounts Project B Costs and Cashflow Elements Money Out AW has asked a price of $121 million, based on their assets, reputation, and annual total income free cash flow This number may be negotiable If WWW did buy AW, the price would be due in year 0 AWs current production capacity is similar to WWWs It might be possible to expand AWs production but that is uncertain at this point and should not be included in your analysis Project B Costs and Cashflow Elements Money In AW currently sells 23,000 widgets annually, at an ATC of $671 and a market price of $850 AW has $1 7 million in annual non operating fixed costs (The CEOs salary, the accounting department, etc) which could be eliminated if they are bought by WWW An additional cost savings of $17 per widget could be obtained on AWs production at any level by combining raw materials orders with WWWs current orders Your Task You must compare both projects, using NPV, IRR and simple breakeven using a cumulative cash flow curve Then you must recommend one project, based on your overall analysis Project A Lay out the complete cashflow curve Start with money out, including initial costs and ongoing maintenance costs Calculate money in (annual net income) using the ATC cost curve from Figure 1 and the demand curve from Figure 2 to determine the best choice for production volume Once you select production volume from the ATC curve, you will know the cost Look at the Demand curve in Figure 2 to see what price you can charge to get to that level of demand Remember that the additional widgets can be produced beginning in year 3 Using the figures you have developed for Money in and Money out across 20 years, lay out the complete cashflow and calculate NPV and IRR, using the WACC rate provided Develop a cumulative cashflow curve across the 20 years and show simple breakeven and maximum cost points Assess risks and describe how you can manage them mitigate them You might decide to add a risk premium to the WACC rate If so, explain this to me Consider intangibles that cannot be included in the cashflow and assess how important they are to this project decision Project B Using the data on AWs production volume along with costs and prices per units, calculate AWs actual NPV using the WACC rate for WWW Remember that this is for an indefinite period so use the in perpetuity model, as well as the TVM approach Lay out the cashflow for a 20 year period for both the $121 million asking price in year Zero (0) and your NPV from the step above Calculate an NPV and IRR for both cashflows Develop a cumulative cashflow curve across the 20 years and show simple breakeven and maximum cost points for the cashflow you think most likely for Project B Assess risks and describe how you can manage them mitigate them Consider intangibles that cannot be included in the cashflow and assess how important they are to this project decision Comparison and Recommendations Compare both projects based on NPV, IRR, Breakeven, risks, and intangibles and make your recommendation to management as to which project should be selected Explain why Background Data WWWs WACC is 4 and is expected to remain constant for the next 20 years WWWs MARR (hurdle Rate) is currently 12 The expected average inflation rate for the next 20 years is 2 The marketing department projects the demand for widgets to remain strong for the foreseeable future but the marketeers dont actually know the future

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WWW will invest considerable amounts into expanding their current widget production capacity. This will involve the construction of a large extension to their existing factory,

WWW will invest considerable amounts into expanding their current widget production capacity. This will involve the construction of a large extension to their existing factory, as well as the purchase of new production equipment, the training of new production workers, and the operation of this new capacity across the next 20 years.

Project A Costs and Cashflow Elements Money Out

The construction of the new factory extension will cost an estimated $8.7 million and will take place in years 1 and 2, with total costs spread evenly across both years.

The new equipment needed to expand production will cost an estimated $6.1 million, which will occur in year 2.

Training for new staff will cost a projected $645,000 in year 2

Maintenance on the building and new equipment will cost an estimated $300,000 annually, beginning at the end of year 2, but is forecast to rise by $12,000 each year for the next 18 years, from year 2 to year 20.

Current non-operating costs and revenues are expected to remain unchanged and can be ignored.

Project A Costs and Cashflow Elements Money In

WWW currently produces 25,000 widgets annually, at an Average Total Cost (ATC) per widget of $652 and a market price of $840 per widget. WWW is a price searcher, so they have been holding production to the level at which they get the lowest ATC

The marketing department is convinced that there would be much larger demand if they could lower the price to $680, but current costs prevent that. Current sales are at 25,000 widgets per year.

Figure 1 shows the projected ATC curve for WWW if they go ahead with Project A. Figure 2 shows the demand curve for Widgets in the current market.

Project B

WWW has an opportunity to buy a nearby competitor Amazing Widgets Inc (AW) who currently produces a widget very similar to WWWs product. The deal would be an outright purchase of the company, with all its current equipment, facilities, employees, assets and liabilities, and customer accounts.

Project B Costs and Cashflow Elements Money Out

AW has asked a price of $121 million, based on their assets, reputation, and annual total income/free cash flow. This number may be negotiable. If WWW did buy AW, the price would be due in year 0.

AWs current production capacity is similar to WWWs . It might be possible to expand AWs production but that is uncertain at this point and should not be included in your analysis.

Project B Costs and Cashflow Elements Money In

AW currently sells 23,000 widgets annually, at an ATC of $671 and a market price of $850.

AW has $1.7 million in annual non-operating fixed costs (The CEOs salary, the accounting department, etc) which could be eliminated if they are bought by WWW.

An additional cost savings of $17 per widget could be obtained on AWs production at any level by combining raw materials orders with WWWs current orders.

Your Task

You must compare both projects, using NPV, IRR and simple breakeven using a cumulative cash flow curve. Then you must recommend one project, based on your overall analysis.

Project A

Lay out the complete cashflow curve. Start with money out, including initial costs and ongoing maintenance costs.

Calculate money in (annual net income) using the ATC cost curve from Figure 1 and the demand curve from Figure 2 to determine the best choice for production volume. Once you select production volume from the ATC curve, you will know the cost. Look at the Demand curve in Figure 2 to see what price you can charge to get to that level of demand. Remember that the additional widgets can be produced beginning in year 3.

Using the figures you have developed for Money in and Money out across 20 years, lay out the complete cashflow and calculate NPV and IRR, using the WACC rate provided.

Develop a cumulative cashflow curve across the 20 years and show simple breakeven and maximum cost points.

Assess risks and describe how you can manage them/mitigate them. You might decide to add a risk premium to the WACC rate. If so, explain this to me.

Consider intangibles that cannot be included in the cashflow and assess how important they are to this project/decision.

Project B

Using the data on AWs production volume along with costs and prices per units, calculate AWs actual NPV using the WACC rate for WWW. Remember that this is for an indefinite period so use the in-perpetuity model, as well as the TVM approach.

Lay out the cashflow for a 20 year period for both the $121 million asking price in year Zero (0) and your NPV from the step above. Calculate an NPV and IRR for both cashflows.

Develop a cumulative cashflow curve across the 20 years and show simple breakeven and maximum cost points for the cashflow you think most likely for Project B.

Assess risks and describe how you can manage them/mitigate them.

Consider intangibles that cannot be included in the cashflow and assess how important they are to this project/decision.

Comparison and Recommendations

Compare both projects based on NPV, IRR, Breakeven, risks, and intangibles and make your recommendation to management as to which project should be selected. Explain why.

Background Data

WWWs WACC is 4% and is expected to remain constant for the next 20 years.

WWWs MARR (hurdle Rate) is currently 12%

The expected average inflation rate for the next 20 years is 2%

The marketing department projects the demand for widgets to remain strong for the foreseeable future but the marketeers dont actually know the future.