Iron Ore What? (IOW) Casting Company is considering adding a new line to its pro

Question

Iron Ore What? (IOW) Casting Company is considering adding a new line to its product mix. Sydney Johnson, a recently minted MBA, will be conducting the capital budgeting analysis. The new production line would be set up in unused space in IOW’s main plant. The machinery invoice price totals approximately $250,000, with another $20,000 in shipping charges and $30,000 to install the equipment, for a total requirement estimated at $300,000. The machinery has an economic life of 4 years, and IOW has obtained a special tax ruling that places the equipment in the Modified Accelerated Cost Recovery System (MACRS) 3-year class. After 4 years of use the machinery is expected to have a salvage value of $25,000. The new product line would generate incremental sales of 1,350 units per year for 4 years at an incremental cost of $100 per unit in the first year, excluding depreciation. Each unit can be sold for $200 each in the first year. The sales price and cost are expected to increase by 3% per year due to inflation. Further, to handle the new line, the firm’s net working capital would have to increase by an amount equal to 15% of sales revenues. The firm’s tax rate is 40%, and its overall weighted average cost of capital is 12%. 7. Explain scenario analysis and any problems, issues, or concerns that surround this type of projection. 8. Define simulation analysis, and discuss its principal advantages and disadvantages.

Explanation / Answer

Sceanrio Analysis

Scenario Analysis is used tto measure the effect of portfolio of simulataneous movements in one or several factors.INa a scenario analysis the user defines the events such as interest rates , changes in currencies , change in volatilities

Potential weakness ina ny scenario analysis include the inability to accurately measure by products of major factor moevemnts or include the smultaneous mpovements of risk factors

Simulation Analysis

Simulation it is methods where infinite calculations are made to calculate the possible outcomes and possibilities of scenario

Advantges

Every possible outcome is measured and analyszed

Forecasting under uncertainity

Disadadavantges

It throws out many outputs which are unnecessary and unwanted. We have to filter out ouputs which are not needed or not possible for our case which is tedious task

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