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 straight line.

REVENUES

In Year 1 of production, you estimate you will produce and sell (A) 5000 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) 2000$ 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 © 1000$ 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) 70% 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%.

DELIVERABLES

prepare a memorandum and supporting materials that include your recommendation and analytical results as to whether the project should be completed.

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

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 Sales Year 1 Year 2 Year 3 Year 4 Year 5 1 Units 5000 5250 5513 5788 6078 Amount in $ 2000 2000 2000 2040 2081 Total Sales 10000000 10500000 11025000 11807775 12646127 2 Cost of Goods Sold Units 5000 5250 5513 5788 6078 Amount in $ 1000 1000 1000 1020 1040 Total Cost of Goods Sold 5000000 5250000 5512500 5903888 6323064 3 Payroll Management Number of Employees 40 40 40 40 40 Cost Per Employee in $ 75000 77250 79568 81955 84413 Total 3000000 3090000 3182700 3278181 3376526 4 Payroll Manufacturing Number of Employees 5 6 6 6 7 Cost Per Employee in $ 55000 56650 58350 60100 61903 Total 275000 339900 321652 347866 433321 5 Bank Charges 50000 52500 55125 59039 63231 6 Employee Training Expense Total Employees 45 46 46 46 47 Cost Per Employee in $ 2500 2575 2652 2732 2814 Total 112500 118450 120711 125085 132247 7 Miscelleneous Expenses Total Sales 10000000 10500000 11025000 11807775 12646127 Misc Expenses@2% 200000 210000 220500 236156 252923 Real Estate Taxes 1200000 1236000 1273080 1311272 1350611 Weighted Average Cost of Capital Particulars Cost Proportion WACC Equity 20 30% 6 Debt 9 70% 6.3 WACC 12.3 Calculation Of Depreciation 1 Factory Cost of the asset 15000000 Life of the asset 39 years Depreciation as per SLM (Cost-Salvage Value)/Life Depreciation per annum 15000000/39 384615 2 Equipmentt in Factory Cost of the asset 9000000 Life of the asset 15 years Depreciation as per SLM (Cost-Salvage Value)/Life Depreciation per annum 9000000/15 600000 3 Furnitures and Fixtures Cost of the asset 5000000 Life of the asset 7 years Depreciation as per SLM (Cost-Salvage Value)/Life Depreciation per annum 5000000/7 714286 Total Depreciation per annum 1+2+3 1698901

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