Write a memo to Mr. Hillbrandt and comment on the three questions below. Limit t

Question

Write a memo to Mr. Hillbrandt and comment on the three questions below. Limit the memo to four or five paragraphs since CEOs want an initial succinct explanation to accompany the financial calculations. Start with an introduction and end with a recommendation. Each of the four or five paragraphs should have a heading.

If the manufacturer plans on using debt to finance the project, should the estimated project cash flows be changed to reflect these interest charges? Why or why not?

If the manufacturer spent $200,000 studying golf clubs last year, should that cost be taken into account with this analysis? Why or why not?

If the manufacturer could rent out the factory that is storing the golf club machinery for $80,000 a year, should that be taken into account with this analysis? Why or why not?

Short Essay (use Word).

If ABC Golf Equipment Corporation goes ahead with this new manufacturing venture, the company may no longer be allowed to represent a competing brand of golf clubs that currently accounts for 20% of its profits. Should this be considered in the analysis? Why or why not? What other factors should be considered in making the decision?

Start with an introduction and end with a summary or conclusion. Use headings. Don’t forget to reference your sources. Maximum length of two pages.

Explanation / Answer

If the manufacturer plans on using debt to finance the project, the estimated cash-flows must be changed to reflect the interest charges. Interest payment involves outgo but at the same time also gives tax-benefit as it is a deductible expense. Hence, the net impact of Interest * (1-tax) must be ascertained on the overall cash-flows. In addition, introduction of debt in the capital structure alters the cost of capital too. Hence, the cost of capital too needs amendments to incorporate debt as a part.

The amount of $200,000 spent by the manufacturer in studying the golf clubs last year, should not be taken into account while doing the analysis. This is so because it is a Sunk Cost. The amount has already been spent and has no relevance any more from cash-flows point of view any more.

If the manufacturer could rent out the factory that is storing the golf club machinery for $80,000 a year then that should be taken into account while doing the analysis. Rental income so foregone is an opportunity cost. The manufacturer could have earned that amount had the project not been accepted. Hence, it is relevant from the point of view of incremental cash-flows calculation and must be included in analysis.

If the golf club manufacturing business takes away profitable sales from the company’s main business of manufacturing refrigerators, that must be taken into account while doing the analysis. The rationale for the same is the same opportunity cost principle. By entering into the venture of manufacturing golf clubs, the manufacturer is sacrificing manufacturing and selling refrigerators – its core business, to that extent. It is very much relevant from incremental cash-flow analysis.

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