FIN440 Capital Budgeting Case - Barrister Industries

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Capital Budgeting Case - Barrister Industries

You are the division finance manager for Barrister Industries, a publicly traded manufacturing company. The division head comes to you very excited, because he just met with a new customer that wants Barrister to be the sole source manufacturer of a key component for one of its current, well selling products. The division head asks you to prepare a financial analysis of whether Barrister should pursue this opportunity.

You discuss the situation with the sales manager and learn that the customer intends to purchase the part from Barrister for the next five years, and will agree to a firm contract for the first three years.

Financial managers budget for unforeseen changes

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How may financial managers budget for unforeseen changes and improvements in information technology that may require large capital outlays?

Capital budgeting analysis - Replacement

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A firm is considering the cost-saving project of replacing an existing copier with a new copier. The existing copier was purchased 8 years ago for $ 100,000 and was expected to last 20 years over which straight-line amortization was used. This existing copier can now be sold for its book value. The new machine costs $120,000,will last 12 years, and is expected to save the firm $20,000 each year before taxes. Assuming a tax rate of 34%, a discount rate of 10% and a zero salvage value for the new machine at the end of its life, what is the NPV for this project?

Principle of Finance II 1-10 Questions

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1.  A firm has a $40 million capital budget limit. Five high IRR projects of about equal size are available that have initial investments totaling $30M. A sixth project has an IRR slightly lower than those of the first five, but requires a $16M investment. Several smaller projects are available with much lower IRR's. Discuss which projects should be done using capital rationing thinking.

2.  When retained earnings are exhausted, the MCC breaks upward. What happens if the firm continues to raise capital after that? Does the MCC remain flat or move further upward? In either case, why?

3.  Describe the difference between fixed and floating exchange rate systems.

Cost Reducing Project

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1. Suppose a firm is considering a labor-saving investment. In year 0, the project requires a $11,700 investment in equipment (all figures are in thousands of dollars). This investment is depreciated using the straight-line method over five years and there is salvage value in year 5 of $4,500. With or without the cost-reducing investment, all cash flows start in year 1 and end in year 5. The inflation rate is 2.6% in year 2 and declines to 1.4% in year 5. The real growth rate is 21.3% in year 2 and declines to 9.5% in year 5. The tax rate is 41.0% in all years. The real cost of capital is 8.7% in year 1 and declines to 7.5% in year 5. Without the cost-reducing investment, the firm's existing investments will generate year 1 revenue, labor costs,

Project Net Present Value

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Note: Tutorial is only for Question 2. Tutorial for Question 1 can be downloaded here.

1. Suppose a firm is considering the following project, where all of the dollar figures are in thousands of dollars. In year 0, the project requires $37,500 investment in plant and equipment, is depreciated using the straight-line method over seven years, and there is a salvage value of $5,600 in year 7. The project is forecast to generate sales of 5,700 units in year 1, rising to 24,100 units in year 5, declining to 8,200 units in year 7, and dropping to zero in year 8. The inflation rate is forecast to be 1.5% in year 1, rising to 2.8% in year 5, and then leveling off. The real cost of capital is forecast to be 9.3% in year 1, rising to 10.6% in year 7. The tax rate is forecast to be a constant 42.0%. Sales revenue per unit is forecast to be $15.30 in year 1 and then grow with inflation. Variable cost per unit is forecast to be $9.20 in year 1 and then grow with inflation. Cash fixed costs are forecast to be $7,940 in year 1 and then grow with inflation. What is the project NPV?

2. Consider the same project as problem 1, but modify it as follows. Suppose that Direct Labor, Materials, Selling Expenses, and Other Variable Costs are forecast to be $5.20, $3.70, $2.30, and $0.80, respectively, in year 1 and then grow with inflation. Lease Payment, 

Project Net Present Value

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1. Suppose a firm is considering the following project, where all of the dollar figures are in thousands of dollars. In year 0, the project requires $37,500 investment in plant and equipment, is depreciated using the straight-line method over seven years, and there is a salvage value of $5,600 in year 7. The project is forecast to generate sales of 5,700 units in year 1, rising to 24,100 units in year 5, declining to 8,200 units in year 7, and dropping to zero in year 8. The inflation rate is forecast to be 1.5% in year 1, rising to 2.8% in year 5, and then leveling off. The real cost of capital is forecast to be 9.3% in year 1, rising to 10.6% in year 7. The tax rate is forecast to be a constant 42.0%. Sales revenue per unit is forecast to be $15.30 in year 1 and then grow with inflation. Variable cost per unit is forecast to be $9.20 in year 1 and then grow with inflation. Cash fixed costs are forecast to be $7,940 in year 1 and then grow with inflation. What is the project NPV? 

Net present Value - Amisha

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In the current year ( year 0), Amisha became a shareholder in Sultan Inc., a calender year S corporation, by contributing $15,000 cash om exchange for stock. Shortly before the end of the year, Sultan's CFO notified Amisha that her pro rata share of ordinary loss for the year would be 55,000. Amisha immediately loaned $40,000 to Sultan in exchange for a two-year, interest-bearing corporate note. Consequently, she had enough stock and debt basis to allow her to deduct the $55,000 loss on her current year return. 

Compute the NPV of Amish's cash flow associated with her loan in the following three cases. In each case, assume she has a 35 percent marginal tax rate on ordinary income, a 15 percent on capital gains, and uses a 6 percent discount rate. 

a. For the next two years (year 1 and 2), Amisha share of Sultans ordinary income totaled $49,000, and sultan did not distrubute any cash to its shareholders. However, it did repay the $40,000 loan plus $3,800 interest in year 2. 

Capital budgeting analysis - Gibson Company invests in Brazil

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The Gibson Company is a United States (US) firm that is considering a joint venture with Brasilia, DF, a Brazilian firm that grows and processes coffee beans. Gibson has a patent for a new coffee processing method. This intellectual property is motivating Gibson to expand beyond importing coffee to engaging in a joint venture to process the coffee. Gibson will invest $8 million in the proposed joint venture project, which will help to finance Brasilia 's production using the newly patented process.
 

The Brazilian government has guaranteed that the after-tax profits (denominated in Reals, the Brazilian currency) can be converted to US dollars at the current exchange rate and sent to the Gibson Company each year. Current exchange rates can be found at http://www.oanda.com.

For each of the first five years, 60 percent of the total profits will be distributed to Brasilia, while the remaining 40 percent will be converted to dollars to be sent to Gibson. The income tax rate for the joint venture will be 10%. However, the Brazilian government is considering raising the income tax rate to 30%. At the present time, the Brazilian government doe not impose a separate income tax on profits sent out of the country.