home / study / questions and answers / business / finance / i need all formulas
ID: 2773625 • Letter: H
Question
home / study / questions and answers / business / finance / i need all formulas shown. atc corporation is a ...
Your question has been answered! Rate it below.
Let us know if you got a helpful answer.
Question
I need all formulas shown.
ATC Corporation is a manufacturer of new and replacement parts for the aircraft industry. The company’s major customers are airlines, other aircraft operators (such as charter services), and contract maintenance service providers. Despite the economic slowdown, the company expects its sales to be strong for the several years, since many aircraft operators will be more interested in maintaining and repairing existing planes rather than buying new ones.
At the present time, ATC is considering an upgrade to its manufacturing facility. This will involve replacing several older machines by the purchase and installation of a new, state of the art, computer-controlled metal cutting and shaping machine center made by a German supplier. Estimates of the machine center’s costs and benefits are shown in the table below, where net cash flows are after-tax. Although the machinery should last for at least ten years, the company uses a five-year planning period for equipment of this type (based on depreciation rules and company policy). Since the machine will not be sold at the end of year 5, there is no salvage value to consider.
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Initial Costs:
Purchase
-3,600,000
Shipping
-150,000
Installation
-250,000
Cash Inflows:
Sale of Old Machines
200,000
Investment Tax Credit
350,000
After-Tax Cost Savings
400,000
420,000
440,000
460,000
480,000
After-Tax New Sales
0
50,000
100,000
120,000
150,000
Depreciation Tax Savings
350,000
600,000
430,000
300,000
200,000
Increased Product Quality
10,000
20,000
25,000
30,000
35,000
Net Cash Flows:
-3,450,000
760,000
1,090,000
995,000
910,000
865,000
Three important things to note are that the above cash flows have been adjusted to include an assumed inflation rate of 3% per year, the company’s average tax rate is 30%, and that the investment project is considered to be 20% riskier than the company’s average investment.
Examination of ATC’s balance sheet reveals that the company uses the following types of financing (all percentages are based on market value).
Financing Type
Percentage of Total Financing
Market Rate of Return
Short-Term Debt
15%
3.5%
Long-Term Debt
30%
5.25%
Preferred Equity
10%
8%
Common Equity
45%
12%
If ATC does not make this equipment investment, it has no other real asset investment projects which it is considering. Therefore, an alternative use of the money in the capital budget would be a purely financial investment, such as stock, bonds, short-term CD’s, and so forth.
1.Based on your knowledge of current and projected economic conditions, does the company’s assumption about future sales sound reasonable to you? Why or why not?
2.What cost of capital should the company use to analyze this investment project?
3.Without considering any other alternatives, is the machine a good investment for the company? Why or why not?
4.Without doing any calculations, discuss some possible alternatives which the company might have in terms of financial investments. Give some specific examples and make sure that you include a consideration of risk as part of your discussion.
5.Which choice would you recommend for the company? Why do you consider this option the best choice?
6.Suppose you are convinced that inflation over the next several years will be higher than the 3% which is forecast in the numbers the company is using in their projections. Without doing any further calculations, explain how you could adjust your analysis to account for this.
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Initial Costs:
Purchase
-3,600,000
Shipping
-150,000
Installation
-250,000
Cash Inflows:
Sale of Old Machines
200,000
Investment Tax Credit
350,000
After-Tax Cost Savings
400,000
420,000
440,000
460,000
480,000
After-Tax New Sales
0
50,000
100,000
120,000
150,000
Depreciation Tax Savings
350,000
600,000
430,000
300,000
200,000
Increased Product Quality
10,000
20,000
25,000
30,000
35,000
Net Cash Flows:
-3,450,000
760,000
1,090,000
995,000
910,000
865,000
Explanation / Answer
a. Given the current economic condition, if the growth in the economy is good, then the projections of the future sales is reasonable. However, if there is a recession, then the sales figure has to be reduced by the proportionate reduction in growth rate.
b. The cost of capital for the company is: 0.15*3.5% +0.3 *5.25% + 0.1 * 8% + 0.45 *12% = 8.3%. The cost of capital for the firm is 8.3%
c. The NPV of the project is as follows:
Year
Net Cash flow
Discounted Cash flow @ 8.3%
0
-3450000
-3450000
1
760000
701754
2
1090000
929329
3
995000
783317
4
910000
661497
5
865000
580596
NPV
206493
Although the NPV is positive it is very less compared to initial investment and the profitability is about 6% (206,493/3,450,000) which Is less than cost of capital. Hence it is not a good project
d. The company has to improve its cash flows considerably to increase the financial viability of the project. Alternately it has to reduce the cost of capital to less than 6%
e. I would recommend the company to identify ways to increase the cash flows over the five year period
f. If the inflation is 3%, the real interest rates would be much less and this would lower the cost of capital for the firm
Year
Net Cash flow
Discounted Cash flow @ 8.3%
0
-3450000
-3450000
1
760000
701754
2
1090000
929329
3
995000
783317
4
910000
661497
5
865000
580596
NPV
206493
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.