problem set 3

Group Problem Set 3: This problem Set is based on materials covered in modules 5 and

6 (weeks 5 and 6). It is designed for you to demonstrate your understanding and be

able to apply basic capital budgeting concepts in deciding whether to undertake an

capital project or not. Before you start this assignment, please review weeks 5 and 5

materials thoroughly.

Adams, Incorporated would like to add a new line of business to its existing retail

business. The new line of business will be the manufacturing and distribution of animal

feeds. This is a major capital project. Adams, Incorporated is aware you an in an MBA

program and would like you to help analysis the viability of this major business venture

based on the following information:

 The production line would be set up in an empty lot the company owns.

 The machinery’s invoice price would be approximately $200,000, another

$10,000 in shipping charges would be required, and it would cost an additional

$30,000 to install the equipment.

 The machinery has useful life of 4 years, and it is a MACRS 3-year asset.

 The machinery is expected to have a salvage value of $25,000 after 4 years of

use.

 This new line of business will generate incremental sales of 1,250 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 in the first year. The sales price

and cost are expected to increase by 3% per year due to inflation.

 Net working capital would have to increase by an amount equal to 12% of sales

revenues. The firm’s tax rate is 40%, and its overall weighted average cost of

capital is 10%.

Required:

1. If the company spent $40,000 last year in the upkeep of the empty lot, should this

cost be included in the analysis? Why or why not?

2. Disregard the assumptions in part 1 above. What is the machinery’s depreciable

basis? What are the annual depreciation expenses?

3. Calculate the annual sales revenues and costs (other than depreciation).

4. Construct annual incremental operating cash flow statements.

5. Estimate the required net working capital for each year based on sales for the

following year. Working capital will be recovered at the end of year 4.

6. Calculate the after-tax salvage cash flow.

7. Calculate the net cash flows for each year. Based on these cash flows, what are

the project’s NPV, IRR, Profitability Index (PI), and payback?

8. Can you use the Payback method to decide whether this is a good project or

not? Why or why not?

9. Interpret what NPV, IRR, and Profitability Index (PI) mean. Based on your

interpretation, do these indicators suggest the new business line should be

undertaken?

Specific Instructions:

1. Complete and submit your assignment no later than the last day of Module 6/Week 6.

2. Include only the names of your group members who participated in this assignment when you submit.

3. Submit only one copy per group. 4. If you use Excel for any of your calculations, please submit the Excel worksheet.

Be sure to label your Excel worksheet appropriately. Use Word for your discussions. Please DO NOT use any other format such PDF, etc. Use APA throughout including in-text citations and references.

5. After you complete the assignment, please give each member opportunity to

review the final paper before you submit it. You are jointly responsible for any

error made.

Side Note: Please note that this is not the type of assignment where the assignment is

divided and each student completes the part that is assigned. Each person in your

group need to participate fully in the completion of this assignment. This is the only way

each group member can master and be able to use the concepts in this assignment.

After you complete the assignment, please give each member opportunity to review the

final paper before you submit it. You are jointly responsible for any error made.

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