Some data: Conch Manufacturing is a start-up manufacturer of Bulldozers, Cranes, and other heavy equipment newly located Zionsville, IN. The company president is Shelly Silverspoon, 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. Silverspoon 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 Silverspoon 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 $27,000,000 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 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 $280,000, variable costs will be $195,000 per unit, and Fixed Costs will be $6,000,000 per year. The company requires an 11 percent return on any new project, and the relevant tax rate is 35%.
Mr. Silverspoon has asked him to provide answers to the following questions:
NOTE: PLEASE ANSWER QUESTION 6 - 21
1. Calculate the base Net Present Value.
2. Based upon the conclusion to #1, should you proceed or not with the project?
3. Consider this project within the context of Sources of Value and issues of Economic Rent. Is it reasonable that the project could produce a positive Net Present Value?
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.
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? (Use the enclosed worksheet so I can see that you understand the process of correctly calculating Sensitivity Analysis.)
7. What is the sensitivity of the project’s NPV to changes in unit sales?
8. What is the sensitivity of the project’s NPV to changes in variable Costs?
9. What is the sensitivity of the project’s OCF to change in unit sales?
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 variable costs?
12. You now have completed the sensitivity analysis for the three variables of Variable Costs, unit sales volume, and Fixed Costs. Write a 5 - 6 sentence conclusion to your boss about your observations and recommendations – so far. Are you concerned that you did not complete a sensitivity analysis for Price? Please also comment on that aspect to your boss.
13. Calculate the Operating Break-Even quantity level at the Base Case for this project.
14. Calculate the Accounting Break-Even quantity level at the Base Case for this project.
15. Calculate the Financial Break-Even level of output at the Base Case for this project.
16. Calculate the Degree of Operating Leverage at the Financial Break-even point.
17. What is the Degree of Operating Leverage at the BASE case of 300 forecasted units?
18. If units sold decrease from 300 units to 150 units, what will be the in Operating Cash Flow dollars?
19. What will be the New Operating Cash Flow assuming 150 units will be the sustainable sales rate?
20. What will be the NEW Degree of Operating Leverage at the newly established sales units of 150 units?
21. 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.