RWE Enterprises: Expansion Project analysis RWE Enterprises, Inc. (RWE) is a sma
ID: 2726976 • Letter: R
Question
RWE Enterprises: Expansion Project analysis
RWE Enterprises, Inc. (RWE) is a small manufacturing firm located in the hills just outside Adelaide, South Australia. The firm is engaged in the manufacrure 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 growti of beef cattle. The final product is put in 50kg or 90kg 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 of a new line. The addition would expand the firm's capacity by almost l20% since the new 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 85 degree Celsius and then must be cooled down before beginning the next batch. The toal production run entails about four hours and the cool-down period is two hours (during which time the whole process comes to a halt). Using two production lines would increase the overall efficienry of the operation since workers from the line that is cooling down could be moved to the other line to support the 'canning' process involved. including the feed tubs.
The second production line equipment would cost $3 million to purchase and install and would have an estimated life of 10 years at which time it could be sold for an estimated after-tax scrap value of $ 200,000. Furthermore, at the end of five years the production line would have to be refurbished at an estimated cost of $2 million. RWE's management estimates that the new production line would add $ 700, 000 per year in after-tax cash flow to the firm. The 10-year cash flows for the line are as follows:
YEAR CASH FLOW
0 - $ 3000 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 105 discount rate to evaluate investments of this type, what is the net present value of the project? What does this NPV indicates about the potentiasl value RWE might create by purchasing the new production line?
c). Calcuate the Payback and discounted Payback for the proposed investment. Interpret your findings.
Explanation / Answer
a) Year After taxCash Flow PV F @ 10.5% PV @ 10.5% 1 2 3 2*3 0 -3000000 1 -3000000 1 700000 0.90498 633486 2 700000 0.81898 573286 3 700000 0.74116 518812 4 700000 0.67073 469511 5 -1300000 0.607 -789100 6 700000 0.54932 384524 7 700000 0.49712 347984 8 700000 0.44989 314923 9 700000 0.40714 284998 10 900000 0.36845 331605 NPV= Sum of Present values = 70029 Positive NPV of $ 70029 indicates that the new production line is profitable c).Payback and discounted Payback for the proposed investment. b. Year After taxCash Flow Cumulative Pay back Discounted AT Cash Flows -From Previous table Cumulative Disc.Pay back 0 -3000000 -3000000 -3000000 -3000000 1 700000 -2300000 633486 -2366514 2 700000 -1600000 573286 -1793228 3 700000 -900000 518812 -1274416 4 700000 -200000 469511 -804905 5 -1300000 -1500000 -789100 -1594005 6 700000 -800000 384524 -1209481 7 700000 -100000 347984 -861497 8 700000 600000 314923 -546574 9 700000 1300000 284998 -261576 10 900000 2200000 331605 70029 Formula to find no.of years Pay back= Year with last Negative Cumulative value(That Absolute Negative cumulative value(ie. With no sign)/Total cash flow of the next year) 7+(100000/700000) 7.14 Years Discounted Payback (Formula is same as above- with discounted cash flows column. 9+(261576/331605) 9.79 Years Pay back= 7.14 Yrs. Discounted Payback 9.79.Yrs. The project pays back within 10 Years. To find the feasibility of a project , cash flows ,both negative(outflows) and positive (Inflows) are discounted at the firm's cost of capital- ie. The rate at which the firm borrows funds to finance the said project. The resultant figure - ie. Net of PVs of inflows and outflows is called the Net Present Value . If it is positive, the project is profitable.Negative NPV does not recommend a project. Here, as the NPV is positive with a value of 70029 ,the project is recommended. NPV gives time value to money as it discounts the cash flows Payback is the measure which gives us an idea about the no. of years it will take to recoup/recover the initial investment. Simple payback uses the cash flows as it is. Whereas discounted payback discounts or attaches time value to the cash flows -to know the time period within which the original investment or cash outlay can be recovered. This is used to compare different projects with different outlays and different patterns of cash flows. This project takes 7.14 years for simple payback and 9.79 years when cash flows are discounted to repay the initial as well as the refurbishment expenses.
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