RWE Enterprises: Expansion Project Analysis RWE Enterprises, Inc. (RWE) is a sma
ID: 2613716 • Letter: R
Question
RWE Enterprises: Expansion Project Analysis RWE Enterprises, Inc. (RWE) is a small manufacturing firm located in the hills just outside of Nashville, TN. The firm is engaged in the manufacture and sale of feed supplements used by cattle raisers. The product has a molasses base but is supplemented with minerals and vitamins that are generally thought to be essential to the health and growth of beef cattle. The final product is put in 125-pound or 200-pound tubs that are then made available for the cattle to lick as desired. The material in the tub becomes very hard, which limits the animals’ consumption. The firm has been running a single production line for the past five years and is considering the addition of a new line. The addition would expand the firm’s capacity by almost 120% since the newer equipment requires a shorter down time between batches. After each production run the boiler used to prepare the molasses for the addition of minerals and vitamins must be heated to 180 degrees Fahrenheit and then must be cooled down before the next batch. The total production run entails about 4 hours and the cool down period is 2 hours (during which time the whole process come to a halt). Using two production lines increases the overall efficiency of the operation since workers from the line that is cooling down can be moved to the other line support the “caning” process involved in filling the feed tubs. The second production line equipment will cost $3 million to purchase and install and will have an estimated life of 10 years at which time it can be sold for an estimated after-tax scrap value of $200,000. Furthermore, at the end of five years the production line will have to be refurbished at an estimated cost of $2 million. RWE’s management estimates that the new production line will add $700,000 per year in after-tax cash flow to the firm such that the full 10-year cash flows for the line are as follows:
Year After-tax Cash Flow
0 $(3,000,000)
1 700,000
2 700,000
3 700,000
4 700,000
5 (1,300,000)
6 700,000
7 700,000
8 700,000
9 700,000
10 900,000
A. If RWE uses a 10% discount rate to evaluate investments of this type, what is the net present value of the project? What does this NPV indicate about the potential value RWE might create by purchasing the new production line?
B. Calculate the internal rate of return and profitability index for the proposed investment. What do these two measures tell you about the project’s viability?
C. Calculate the payback and discounted payback for the proposed investment. Interpret your findings.
Explanation / Answer
Computation of net present value
Year Profit after tax depreciation cash inflows discount @10% PV cash inflows
1 700000 280000 980000 0.909 890820
2 700000 280000 980000 0.826 809480
3 700000 280000 980000 0.751 735980
4 700000 280000 980000 0.683 669340
5 700000 200000 900000 0.620 558000
6 700000 200000 900000 0.564 507600
7 700000 200000 900000 0.513 461700
8 700000 200000 900000 0.466 419400
9 700000 200000 900000 0.424 381600
10 900000 200000 1100000 0.385 423500
total cash inflows 5857420
cash outflows (5000000)
net present value 857420
Computation profitability index
Profitability index = PV of cash inflows / PV of cash outflows
= 5857420 / 5000000
= 1.17
Computation of internal rate of return
Years cash inflows discount@ 10% PV cash inflows discount@12% PV cash inflows
1 980000 0.909 890820 0.892 874160
2 980000 0.826 809480 0.797 781060
3 980000 0.751 735980 0.711 696780
4 980000 0.683 669340 0.635 622300
5 900000 0.620 558000 0.567 510300
6 900000 0.564 507600 0.506 455400
7 900000 0.513 461700 0.452 406800
8 900000 0.466 419400 0.403 362700
9 900000 0.424 381600 0.360 324000
10 1100000 0.385 423500 0.322 354200
total cash inflows 5857420 5387700
less cash outflows (5000000) (5000000)
net present value 857420 387700
IRR = lower rate + lower rate NPV/ lower rate NPV - higher rate NPV * difference factor
= 10 + 857420 /857420+387700 * 2
= 11.37%
computation of payback period and Discounted payback period
Year cash inflows cumulative cashflows discount@10% PV cashflows cumulative cashflows
1 980000 980000 0.909 890820 890820
2 980000 1960000 0.826 809480 1700300
3 980000 2940000 0.7510 735980 2436280
4 980000 3920000 0.683 669340 3105620
5 900000 4820000 0.620 558000 3663620
6 900000 5720000 0.564 507600 4171220
7 900000 6620000 0.513 461700 4632920
8 900000 7520000 0.466 419400 5052320
9 900000 8420000 0.424 381600 5433920
10 1100000 9520000 0.385 423500 5857420
payback period = 3.06
discounted payback period = 3.84
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