Finance Week 6 Assignment
Shrieves Casting Company
Write a 750 to 1000 word paper. In your paper include the following:
Complete questions A through J for the Mini Case involving Shrieves Casting Company on pages 495 &
496. Please complete the paper in actual paper format including an introduction paragraph, a clearly
labeled paragraph for each question (A, B, C, etc.), a conclusion paragraph, and a references page.
Include a title page and 3-5 references. Only one reference may be from the internet (not
Wikipedia). The other references must be from the Grantham University online library. Please adhere
to the Concise Guide to APA Style when writing and submitting assignments and papers.
Mini Case
Shrieves Casting Company is considering adding a new line to its product mix, and the capital budgeting
analysis is being conducted by Sidney Johnson, a recently graduated MBA. The production line would be
set up in unused space in the main plant. The machinerys invoice price would be approximately
$200,000, another $10,000 in shipping charges would be required, and it would cost an additional
$30,000 to install the equipment. The machinery has an economic life of 4 years, and Shrieves has
obtained a special tax ruling that places the equipment in the MACRS 3-year class. The machinery is
expected to have a salvage value of $25,000 after 4 years of use.
The new line would generate incremental sales of 1,250 units per year for 4 years at an incremental cost
of $100 per unit in the first year, excluding depreciation. Each unit can be sold for $200 in the first year.
The sales price and cost are both expected to increase by 3% per year due to inflation. Further, to
handle the new line, the firms net working capital would have to increase by an amount equal to 12% of
sales revenues. The firms tax rate is 40%, and its overall weighted average cost of capital, which is the
risk-adjusted cost of capital for an average project (r), is 10%.
a. Define incremental cash flow.
1. Should you subtract interest expense or dividends when calculating project cash flow?
2. Suppose the firm spent $100,000 last year to rehabilitate the production line site.
Should this be included in the analysis? Explain.
3. Now assume the plant space could be leased out to another firm at $25,000 per year.
Should this be included in the analysis? If so, how?
4. Finally, assume that the new product line is expected to decrease sales of the firms
other lines by $50,000 per year. Should this be considered in the analysis? If so, how?
b. Disregard the assumptions in Part a. What is the depreciable basis? What are the annual
depreciation expenses?
c. Calculate the annual sales revenues and costs (other than depreciation). Why is it important to
include inflation when estimating cash flows?
d. Construct annual incremental operating cash flow statements.
e. Estimate the required net working capital for each year and the cash flow due to investments in
net working capital.
f.
Calculate the after-tax salvage cash flow.
g. Calculate the net cash flows for each year. Based on these cash flows and the average project
cost of capital, what are the projects NPV, IRR, MIRR, PI, payback, and discounted payback? Do
these indicators suggest that the project should be undertaken?
h. What does the term risk mean in the context of capital budgeting; to what extent can risk be
quantified; and, when risk is quantified, is the quantification based primarily on statistical
analysis of historical data or on subjective, judgmental estimates?
i.
1. What are the three types of risk that are relevant in capital budgeting?
2. How is each of these risk types measured, and how do they relate to one another?
3. How is each type of risk used in the capital budgeting process?
j.
1. What is sensitivity analysis?
2. Perform a sensitivity analysis on the unit sales, salvage value, and cost of capital for the
project. Assume each of these variables can vary from its base-case, or expected, value
by ±10%, ±20%, and ±30%. Include a sensitivity diagram, and discuss the results.
3. What is the primary weakness of sensitivity analysis? What is its primary usefulness?
Total Risk Evaluation for Capital Budgeting retrieved from
https://web.s.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=16&sid=8c765c58-5ddd-4a8f-b5420e3c17a9f7b7%40redis
A Refresher on Internal Rate of Return retrieved from
https://web.s.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=14&sid=8c765c58-5ddd-4a8f-b5420e3c17a9f7b7%40redis
EQUIVALENT, INCIDENTAL AND INCREMENTAL CASH FLOWS retrieved from
https://web.s.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=8&sid=8c765c58-5ddd-4a8f-b5420e3c17a9f7b7%40redis
Total Risk Evaluation for Capital Budgeting
Journal of Applied Finance Roundtable Discussion
