You are the VP of Finance for a manufacturing firm. The CFO has asked you to ana

Question

You are the VP of Finance for a manufacturing firm. The CFO has asked you to analyze the development of a new factory and report back regarding the financial feasibility of the project. To complete the analysis, you will prepare a 5-year financial projection, and compute the Net Present Value and IRR for the project.

CAPITAL INVESTMENT

The capital investment (Year 0) for the new factory will consist of:

$15,000,000 for construction of the factory itself, with a depreciable life of 39 years.

$9,000,000 for equipment installed in the factory, with a depreciable life of 15 years.

$5,000,000 for furniture and fixtures in the factory, with a depreciable life of 7 years.

Your company’s method of depreciation is a straight line.

REVENUES

In Year 1 of production, you estimate you will produce and sell (A)________________ units.

Year 2 production will be 5% greater than Year 1

Year 3 production will be 5% greater than Year 2

Year 4 production will be 2% greater than Year 3

Year 5 production will be 2% greater than Year 4

In Year 1 of production, you estimate your sales price will be (B) ______________ per unit.

The sales price in Years 2 and 3 will be the same as Year 1.

The sales price in Year 4 will be 2% higher than Year 3.

The sales price in Year 5 will be 2% higher than Year 4.

COST OF GOOD SOLD

Your Cost of Goods Sold will be (C)__________________ per unit in Year 1.

Years 2 and 3 will be the same as Year 1.

Year 4 will be 2% greater than Year 3.

Year 5 will be 2% greater than Year 4.

EXPENSES

Payroll – Management: Management payroll will consist of 40 employees. Management payroll for Year 1 is $75,000 per Management employee. Management payroll per employee will increase 3% each year.

Payroll – Manufacturing: Manufacturing payroll will consist of 1 employee for each 1,000 units produced and sold in a year. Manufacturing payroll for Year 1 is $55,000 per Manufacturing employee. Manufacturing payroll per employee will increase 3% each year.

Bank Charges Expenses will be equal to ½ of 1% (.005) of Total Revenues each year.

Employee Training Expense will be equal to $2,500 per employee. The cost per employee will increase each year by an estimated inflation amount equal to 3%.

The following expenses are a fixed estimate grown each year by the inflation estimate

EXPENSE NAME

YEAR 1 EXPENSE

ANNUAL GROWTH RATE

Insurance

$100,000

3%

Maintenance

$500,000

3%

Office Equipment and Supplies

$250,000

3%

Professional Fees (Legal / Accounting)

$3,000,000

3%

Real Estate Taxes

$1,200,000

3%

Telephone and Communications

$450,000

3%

Utilities

$1,000,000

3%

Miscellaneous Expense will be equal to 2% of Total Revenues each year.

INCOME TAXES

Your company income tax rate is 34%

RESIDUAL VALUE / HORIZON VALUE / TERMINAL VALUE

Your assumption for Operating Cash Flows for Year 6+ are that the Cash Flow from Year 5 will continue at a constant value into the future (aka: a perpetuity)

WEIGHTED AVERAGE COST OF CAPITAL

It is assumed that the project will be capitalized with (D)______% long-term debt at a gross rate of 9.00%. The balance of the capital will be common stock, with a projected cost of 20%.

RECOMMENDATION: In this paragraph, you simply state your recommendation. Something like… I have prepared an analysis of the construction of the new factory. Based on my analysis, I believe we should pursue (or not pursue) development of the new factory.

ANALYTICAL RESULTS: My analysis included a Net Present Value analysis and calculation of the Internal Rate of Return. I have calculated a projected NPV of $____________ and an IRR of ____%. Describe why these are good or not so good values. This is the basis for your recommendation above.

ATTACHED MATERIALS

Exhibit A: Total Capital Investment and Annual Depreciation Calculation

Exhibit B: 5 Year Projection of Operating Cash Flows (This will be an income statement)

Exhibit C: Summary of Weighted Average Cost of Capital Calculation

Exhibit D: Calculation of Net Present Value and Internal Rate of Return

EXPENSE NAME

YEAR 1 EXPENSE

ANNUAL GROWTH RATE

Insurance

$100,000

3%

Maintenance

$500,000

3%

Office Equipment and Supplies

$250,000

3%

Professional Fees (Legal / Accounting)

$3,000,000

3%

Real Estate Taxes

$1,200,000

3%

Telephone and Communications

$450,000

3%

Utilities

$1,000,000

3%

Explanation / Answer

IRR of the Project is where NPV is Zero

Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Sales 10000000 10500000 11025000 11807775 12646127 Less Cost of Goods Sold 5000000 5250000 5512500 5903888 6323063.5 Payroll Management 3000000 3090000 3182700 3278181 3376526.4 Payroll Manufacturing 275000 339900 321651.6 347866.2 433321 Bank Charges 50000 52500 55125 59039 63231 Employee Training Expense 112500 118450 120711 125085 132247 Insurance 100000 103000 106090 109273 112551 Maintenance 500000 515000 530450 546364 562754 Office Equipment and Supplies 250000 257500 265225 273182 281377 Professional Fees 3000000 3090000 3182700 3278181 3376526 Telephone and Communications 450000 463500 477405 491727 506479 Utilities 1000000 1030000 1060900 1092727 1125509 Miscelleneous Expenses 200000 210000 220500 236156 252923 Depreciation 1698901 1698901 1698901 1698901 1698901.1 Total Expenses 15636401 16218751 16734858 17440568 18245409 Net Operating Income -5636401 -5718751 -5709858 -5632793 -5599282 Taxes 0 0 0 0 0 Add Depreciation 1698901 1698901 1698901 1698901 1698901.1 Net Operating Income -3937500 -4019850 -4010957 -3933892 -3900381 Discounting Factor @12.3% 0.89 0.79 0.71 0.63 0.56 Discounted Cash Flows -3506233 -3187501 -2832101 -2473452 -2183777 Total Cash Flows -14183064 -43183064 NPV=Total Discounted Cash Inflows-Cash Outflows NPV=-14183064-29000000 -43183063.79 Since NPV is Negative the project should not be accepted

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