ENDURING IMPRESSIONS COMPANY 2016 Enduring Impressions Company is a medium-sized
ID: 2465351 • Letter: E
Question
ENDURING IMPRESSIONS COMPANY 2016
Enduring Impressions Company is a medium-sized commercial printer of promotional
advertising brochures, booklets, and other direct-mail pieces. The firm's major clients are ad agencies. The typical job is characterized by high quality and production runs of more than 50,000 units. The company has not been able to compete effectively with larger printers because of its existing old, inefficient press. The firm is currently having problems cost-effectively meeting run length requirements as well as meeting quality standards.
The Operations Manager has proposed the purchase of one of two large, six-colour presses designed for long, high-quality runs. The purchase of a new press would enable the company to reduce its cost of labour and therefore the price to the client, putting the firm in a more competitive position. The key financial characteristics of the old press and of the two proposed presses are summarized in the following:
Current Press
Originally purchased 3 years ago at an installed cost of $500,000, it is being depreciated under MACRS using a 7-year recovery period. The current press has a remaining economic life of 5 years. It can be sold today to net $200,000 before taxes; if it is retained, it can be sold to net 50,000 before taxes at the end of 5 years.
Press SAP
This semi-automatic press can be purchased for $750,000 and will require $50,000 in installation costs. It will be depreciated under MACRS using a 5-year recovery period. At the end of the 5 years, the machine could be sold to net $500,000 before taxes. If this press is acquired, it is anticipated that the current account increases shown in Table 1 would be required.
Press AP
This fully automated press costs $1,120,000 and requires $80,000 in installation costs. It will be depreciated under MACRS using a 5-year recovery period. At the end of 5 years, it can be sold to net $700,000 before taxes. If this press is acquired, it is anticipated that the current account increases shown in Table 1 would be required.
The firm estimates that its EBDIT with the Current Press, or Press SAP or Press AP for each of the next 5 years would be as shown in Table 2. The firm is subject to a 40% tax rate. The firm's cost of capital is 16%.
Required:
1. For each of the two proposed replacement Presses SAP and AP, determine:
(a) Initial Investment.
(b) Operating Cash Inflows. (Note: Be sure to consider the depreciation in year 6.)
(c) Terminal Cash Inflow. (Note: This is at the end of year 5.)
2. Using the data developed in Question 1, find and depict on a time line the relevant cash flow streams associated with each of the two proposed replacement presses, assuming that each is terminated at the end of 5 years.
3. Using the data developed in Question 2, apply each of the following decision techniques:
(1) Payback period.
(2) Net Present Value (NPV).
(3) Internal Rate of Return (IRR).
4. Draw Net Present Value Profiles for the two replacement presses on the same set of axes, and discuss conflicting rankings of the two presses, if any, resulting from use of NPV and IRR decision techniques.
5. Recommend which, if either, of the presses the firm should acquire if the firm has
(a) unlimited funds
(b) capital rationing.
6. Recommend what could be done if the cash inflows associated with Press AP are
characterized as very risky in contrast to the low-risk operating cash inflows of Press SAP?
Table 1
Current Account Items
Press SAP
Press AP
Cash
$ 200,000
$ 300,000
Accounts Receivables
300,000
400,000
Inventory
300,000
400,000
Accounts Payables
150,000
200,000
Accruals
80,000
100,000
Table 2
Earnings Before Depreciation, Interest, and Taxes
Year
Current Press
Press SAP
Press AP
1
$ 400,000
$ 900,000
$ 1,100,000
2
400,000
900,000
1,150,000
3
400,000
900,000
1,200,000
4
400,000
900,000
1,250,000
5
400,000
900,000
1,300,000
Current Account Items
Press SAP
Press AP
Cash
$ 200,000
$ 300,000
Accounts Receivables
300,000
400,000
Inventory
300,000
400,000
Accounts Payables
150,000
200,000
Accruals
80,000
100,000
Explanation / Answer
npv = present value of cashinflows - present value of cash out flows
payback period = present value of cashinflows / present value of cash out flows
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