Conch Manufacturing is a start-up manufacturer of Bulldozers, Cranes, and other
ID: 2817204 • Letter: C
Question
Conch Manufacturing is a start-up manufacturer of Bulldozers, Cranes, and other heavy equipment newly located Zionsville, IN. The company president is Shelly Silver-Spooninhismouth, who inherited the company, and he intends to replace Caterpillar as the world’s leader for heavy equipment manufacturing. His sales team consists of the recently retired sales managers of Caterpillar. The company bought an abandoned GM plant on the west side of Indianapolis and will remodel that to produce heavy equipment. The company was founded three years ago. Jay Spreadsheet, a recent IUPUI graduate, has been hired by the company into its finance department. Silver-Spooninhismouth has been surveying the context of the economic environment and is confident that he can readily overtake Caterpillar. After all, he has an experienced sales team, a low-overhead, abandoned building for the manufacturing site, and close proximity to railroad facilities as well as the Indianapolis International Airport for parts delivery. He assumes the production process will be fairly easy in that he has hired Dave Vaporware, a recent graduate of IUPUI in Motorsports Technology, who understands speed. Jay assumes that the knowledge of speed can be easily transferred into mass production process for heavy equipment and make the process speedy. Jay needs to invest in some manufacturing robots to assemble the heavy equipment. He has located an assembly robot at the suggestion of Dave Vaporware. The robot will be programmed to assemble all 750,000 parts of a bulldozer including engine installation and testing, painting, and other speedy details. Dave Vaporware has told both Shelly Silver-Spooninhismouth and Jay Spreadsheet that he can reduce the production time from 180 days to 30 days.
The following data relates to the new Robot. The One Robot carries an Initial Investment outlay $10,000,000 that includes cost of the robot, shipping and installation, a working capital parts inventory to keep this monstrosity in operation, and the cost of financing via the use of internal cash on the balance sheet. Jay Spreadsheet knows that cash on the balance sheet only equals $75,000; i.e., practically zero in the overall context. A very reliable financial advisor with significant commercial experience in the area of external financing alternatives between debt vs. equity financing for projects indicated to Jay Spreadsheet that he should use a Convertible Bond which itself will carry a Flotation Cost equal to 6% of the project. Jay now wishes he hadn’t skipped the last slide in his professor’s external financing lecture about how flotation costs affect capital budgeting. The One Robot will have an estimated five year life, and have no salvage value at the end. Depreciation is straight-line to zero. Sales are projected at 300 units per year. Price per unit will be $310,000, variable costs will be $195,000 per unit, and Fixed Costs will be $7,000,000 per year. The company requires an 12 percent return on any new project, and the relevant tax rate is 24%.Mr. Silver-Spooninhismouth has asked Jay Spreadsheet to provide answers to the following questions:
I NEED HELP WITH THE WHOLE PROBLEM, WITH STEP BY STEP SOLUTIONS BESIDES THE TWO PAGE. THANKS.
1. Within the context of the Economic Cycle, describe and discuss Sources of Value related to The One Robot. What is the reasonableness of this project being undertaken from Sources of Value practicalities?
2. Calculate the base-case Net Present Value.
3. Based upon the conclusion to #2, should you proceed or not with the project? Explain....
4. Analyze this project using a Scenario Analysis. You will assume that price, unit sales, variable costs, and fixed costs are accurate to within +/- 15%. Calculate the Optimistic-case NPV and the Pessimistic-case NPV. Show your work for the Base Case, Optimistic Case, and Pessimistic Case.
5. Based upon your work from #4, write a 2 – 3 sentence analysis of your findings/recommendations; i.e., does the NPV hold at the Optimistic and the Pessimistic assumption? If not, then what might you recommend as a next step?
6. What is the sensitivity of the project’s NPV to changes in Fixed Costs?
7. What is the sensitivity of the project’s NPV to changes in Sales Quantity?
8. What is the sensitivity of the project’s NPV to changes in Variable Costs?
9. What is the sensitivity of the project’s NPV to changes in Price
10. What is the sensitivity of the project’s OCF to changes in Fixed Costs?
11. What is the sensitivity of the project’s OCF to changes in Sales Quantity
12. What is the sensitivity of the project’s OCF to changes in Variable Costs?
13. What is the sensitivity of the project’s OCF to changes in Price?
14. You now have completed the scenario and sensitivity analyses for all variables. Write a two-page conclusion to your boss, Jay Spreadsheet, about your observations and recommendations – so far. NOTE: Jay Spreadsheet may have graduated from IUPUI with a major in Finance; HOWEVER, he minored in English Composition and thus expects a professionally written, two-page paper!!!
15. Calculate the Operating Cash Break-Even quantity level at the Base Case for this project.
16. Calculate the Accounting Break-Even quantity level at the Base Case for this project.
17. Calculate the Financial Break-Even level of output at the Base Case for this project.
18. Calculate the Degree of Operating Leverage at the Financial Break-even point.
19. What is the Degree of Operating Leverage at the BASE case of 300 forecasted units?
20. If units sold decrease from the projected 300 units per year to only 150 units per year, what will be the decrease in Operating Cash Flow dollars? Recalculate the NPV assuming 150 units instead of the original base case that assumed 300 units.
21. What will be the New Operating Cash Flow assuming 150 units will be the sustainable sales rate?
22. What will be the NEW Degree of Operating Leverage at the newly established sales units of 150?
23. Now based upon your overall analysis of this project, summarize your observations and recommendations to your boss about whether this project should, after all, be pursued. Factor into the discussion the NPV assuming 150 unit sales and the Risks of the project per DOL
Explanation / Answer
I am answering Questions 2 to 5. Please ask the other parts separately to get them answered.
2.
Note that to find NPV, we are not concerned with the financing cost because the minimum required return has been given as 12%. We’ll use it to calculate the NPV.
We have the following cash flows associated with the Robot.
As you can see, the NPV, base case is $67,070,115.20.
3.
We know the NPV is the measure of profitability of a any project. When the NPV is positive, it means that the value that is generated by the project is higher than the associated costs. Therefore, as NPV in positive here ( calculated above ), company should proceed with the project.
4.
For the Optimistic Case, I’ll increase the price per unit and the no. of units sold by 15% and will reduce all the costs by 15%. We get the following cash flows:
NPV is $196589543.9
For the pessimistic Case, I’ll assume that the price and no. of units sold go down by 15% and all costs go up by 15%
We have the following Cash flows:
As you can see, the NPV is negative.
5.
We observe from above calculations that NPV is positive for the base case and optimistic case, but is negative for the pessimistic case. Thus, the next step would be to analyse the economic variables and assign probabilities to the possible scenarios. Then we need to calculate probability weighted NPV for the project and if that comes out to be positive after considering for any margins of safety, project should be undertaken.
Base Case Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Outlay -10000000 Revenue 93000000 93000000 93000000 93000000 93000000 Variable Cost 58500000 58500000 58500000 58500000 58500000 Fixed Cost 7000000 7000000 7000000 7000000 7000000 Depreciation 2000000 2000000 2000000 2000000 2000000 Operating Income 25500000 25500000 25500000 25500000 25500000 Taxes 6120000 6120000 6120000 6120000 6120000 Operating Income after tax 19380000 19380000 19380000 19380000 19380000 Ad Back: Depreciation 2000000 2000000 2000000 2000000 2000000 Post Tax Cash slow 21380000 21380000 21380000 21380000 21380000 NPV 67070115.21Related Questions
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