PROBLEM #1: CAPITAL INVESTMENT ANALYSIS Arroyo Company is considering investing in a second manufacturing plant, due its recent growth in sales.
The proposed plant would require an initial cash investment of $600,000.
The plant would have a two-year life.
Forecasted cash revenues and cash costs are:
Cash revenues
Year 1: 235,000 units to be sold at $2.10 each
Year 2: 250,000 units to be sold at $2.25 each
Cash costs
Fixed costs: $120,000 in year #1 and $125,000 in year #2
Variable costs: $.25 per unit in year #1 and $.30 per unit in year #2
Additionally, the project will provide salvage value of $25,000 at the end of year #2. Arroyo Company requires a 10% return on investment.
Required: (Show all work and steps)
1. Calculate the net cash flows for year #1 and year #2. Include the salvage value as a cash receipt at the end of year #2.
2. Compute the present value of net cash flows. Should Arroyo invest in the project?
3. Now, suppose interest rates rise as the Federal Reserve Board raises interest rates to combat inflation. The company now requires a 12% return. Using net present value techniques recalculate the net present value of the project, using a discount rate of 12%. Should Arroyo invest in the project?
4. What do the results of this problem tell you about the effects of rising interest rates on capital investments?
PROBLEM #1: CAPITAL INVESTMENT ANALYSIS Arroyo Company is considering investing in a second manufacturing plant, due its recent growth in sales.
The proposed plant would require an initial cash investment of $600,000.
The plant would have a two-year life.
Forecasted cash revenues and cash costs are:
Cash revenues
Year 1: 235,000 units to be sold at $2.10 each
Year 2: 250,000 units to be sold at $2.25 each
Cash costs
Fixed costs: $120,000 in year #1 and $125,000 in year #2
Variable costs: $.25 per unit in year #1 and $.30 per unit in year #2
Additionally, the project will provide salvage value of $25,000 at the end of year #2. Arroyo Company requires a 10% return on investment.
Required: (Show all work and steps)
1. Calculate the net cash flows for year #1 and year #2. Include the salvage value as a cash receipt at the end of year #2.
2. Compute the present value of net cash flows. Should Arroyo invest in the project?
3. Now, suppose interest rates rise as the Federal Reserve Board raises interest rates to combat inflation. The company now requires a 12% return. Using net present value techniques recalculate the net present value of the project, using a discount rate of 12%. Should Arroyo invest in the project?
4. What do the results of this problem tell you about the effects of rising interest rates on capital investments?
Related questions
Capstone Quarry is analyzing whether a new contract proposal will be a good idea. The relevant data is shown below. The net working capital will be paid in the same time period as the cost of the equipment and will be recovered at the end of the project. Remember to calculate the after-tax gain or loss of salvage as part of your terminal cash flow.
| Capstone Quarry Company Contract Analysis | |
| Amount of Rock Salt per Year | 23,000 Tons |
| Revenue per Ton | $ 145 |
| Cost of Equipment | $ 2,750,000 |
| Life(years) | 5 |
| MACRS Class | 5 |
| Fixed Cost per year | $ 475,000 |
| Var Cost/Ton | $ 85 |
| Actual Salvage | $ 105,000 |
| Change in NWC | $ 85,000 |
| Required Return | 12% |
| Tax Rate | 34% |
Find the cash flows for each year
Net present value
Payback period
Discounted payback
IRR
MIRR
Hint:
| Annual Cash Flows for Capstone Quarry | ||||||
| Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
| Initial Outlay | ||||||
| Unit Sales | ||||||
| Sales | ||||||
| Variable Costs | ||||||
| Fixed Costs | ||||||
| Depreciation | ||||||
| Taxable Cash Flows | ||||||
| Taxes | ||||||
| Add: Depreciation | ||||||
| Annual After-Tax Cash Flow | ||||||
| Terminal Cash Flow | ||||||
| Total Annual Cash Flows | ||||||
