Case Study

Siddhant Nichani

T00589879

Amrik Singh

T00581906

Memorandum

To: Cathy Petty, Vice-President Marketing

From: Dave Pawluk, Team Leader

Subject: Financial Feasibility of Proposed Wind Turbines and Sail Boats Projects

Date: March 25, 2018

The financial feasibility report is prepared to analyze the expansion plan of Capella Industries Ltd. CAPELLA Industries Ltd. is a manufacturer of high-end inflatable boats and boat motors, which has been operating in Canada for over 35 years. It manufactures its inflatable boats in Didsbury, Alberta and its motors in Rocanville, Saskatchewan and sells them both domestically and internationally. The company has been very successful financially, but the board of directors feels that these two products do not offer strong potential for continued growth. One option for expansion is to manufacture commercial wind turbines, which will be sold primarily to construction companies, farmers, ranchers, the military, the resort industry, and municipal governments. The company feels that this new business has potential given high fuel costs, but it does realize it will be selling to the commercial market in which it has no previous sales experience. A second option is to expand their line of boats to include sail boats of various sizes. This expansion will allow the company to continue to focus on the consumer market and utilize its existing selling network

This feasibility report aims at analyzing the options available for the company with regard to two projects. The report discusses about the cost involved in the project and the expected rate of return of the project along with NPV.

Cost of Capital

Cost of capital refers to the opportunity cost of making a specific investment. It is the rate of return that could have been earned by putting the same money into a different investment with equal risk. Thus, the cost of capital is the rate of return required to persuade the investor to make a given investment. The cost of capital is the sum of cost of equity and cost of debt. In this feasibility report the cost of capital is calculated after considering all the possible options of financing activity. The two projects of the company are financed using equity and the debt. Although there are two projects we need to calculate the cost of capital for the firm as a whole.

The cost of equity is calculated using the CAPM Model where in Beta is calculated in the beginning. Using the CAPM Model and the information related to Risk Free Rate and market risk premium the cost of equity is calculated. The cost of equity for both the projects remains the same as it is concerned with the firm and not with the individual projects. The cost of equity is 9.62%. The cost of debt is calculated using the tax rate prevailing in the market. The cost of debt as per the calculations is 4.615%. The WACC is calculated using the cost of debt and cost of equity. As per the calculations the WACC for the company is 7.618%.

Capital Budgeting

The capital budgeting decisions are very important for the firm because the success and failure of a project can be analyzed using the capital budgeting techniques. The Net Present Value of both the projects is calculated in order to understand the financial feasibility of the projects.

The NPV of Wind Turbine project is 208,089,482 and the NPV of sail boats is 132,014,683. So, with the help of NPV we can say that the project of Wind Turbine is more feasible than Sail Boat project.

Recommendations

The calculations of NPV clearly suggests us that the NPV of Wind Turbines project is higher that the NPV of Sail boats. So, it is advisable for the company to accept the project of Wind Turbine over the project of Sail boats. Since the NPV is positive for both the projects the company can accept both. But if the company want to choose only one project then it is always advisable to choose Wind Turbine project over Sail Boats.

Exhibit 1

Cost of Capital Calculation: Wind Turbines

Cost of Equity

The cost of equity would be found out using the CAPM Model.

So Cost of Equity =

Ks = Krf + ( (Km - Krf)

= 0.035 + 1.36 (0.045)

Cost of Equity = 9.62%

Cost of Debt

Cost of Debt = I (1 – Tax Rate)

Cost of Debt = 0.071 ( 1 – 0.35)

Cost of Debt = 4.615%

Weighted Average Cost of Capital

WACC = wd (cost of debt) + ws (cost of stock/RE)

WACC = 0.40 (4.615%) + 0.60 (9.62%)

WACC = 7.618%

Exhibit 2

Cost of Capital Calculation: Sail Boats

Cost of Equity

The cost of equity would be found out using the CAPM Model.

So Cost of Equity =

Ks = Krf + ( (Km - Krf)

= 0.035 + 1.36 (0.045)

Cost of Equity = 9.62%

Cost of Debt

Cost of Debt = I (1 – Tax Rate)

Cost of Debt = 0.071 ( 1 – 0.35)

Cost of Debt = 4.615%

Weighted Average Cost of Capital

WACC = wd (cost of debt) + ws (cost of stock/RE)

WACC = 0.40 (4.615%) + 0.60 (9.62%)

WACC = 7.618%

Exhibit 3

Net Present Value: Wind Turbines

Land	-1,540,000
Building	-5,940,000
Equipment	-12,850,000
1CCA tax shield - building	793,867
2CCA tax shield - equipment	3,561,645
3Issuance Cost	178,760
Change in networking Capital	-550,000
Incremental cash flows	208,089,482
Overhaul	-
CCA tax shield - overhaul	-
4Sale of land	769,800
Capital Gain - land	-72,786
Sale of building	-
Lost CCA tax shield building	-
Sale of equipment	-
Lost CCA tax shield equipment	-
Change in networking Capital	126,385
Net Present Value	192,567,153

1CCA tax shield – building:

(5,940,000)(.35)(.05/(.05+.0763))((2+.0763)/2(1+.0763)) = 793,867

2CCA tax shield – equipment:

(12,850,000)(.35)(.05/(.05+.0763))((2+.0763)/2(1+.0763)) = 3,561,645

3Insuance costs:

Weighted average insuance cost = (.04)(.0325) = .013 or 1.3%

(Total capital to raise)(1-Insuance costs) = (Total capital needed)

(Total capital to raise)(1-.013) = 1,540,000 + 5,940,000 + 12,850,000 + 550,000

4Sale of land:

(3,350,000)/(1 + .0763)20 = 769,800

5Capital Gain – Land:

Profit from land disposal: 3,350,000 – 1,540,000 = 1,810,000

Tax paid from land disposal: (1,810,000/2)*.35 = 316,750

Tax paid from land disposal – NPV: (316,750)/(1+.0763)20 = 72,786

6Change in net working capital:

(550,000)/(1+.0763)20 = 126,385

Incremental Cash Flow Calculation Year 1 - 9

	1	2	3	4	5	6	7	8	9
Sale in Units	5300	5830	6413	7054	7760	8536	9389	9765	10155
Sales Prices(retailer)	21450	21450	21450	21450	21450	21450	21450	21450	21450
Sales Prices(military)	19305	19305	19305	19305	19305	19305	19305	19305	19305
Unit Cost	16850	16850	16850	16850	16850	16850	16850	16850	16850
R&D Costs	-	-	-	-	-	-	-	-	-
Incremental Non traceable factory cost	1410000	1410000	1410000	1410000	1410000	1410000	1410000	1410000	1410000
Incremental selling cost	1054978	114476	1179923	1251916	1331107	1481218	1514040	1556201	1600049
Incremental administration cost	462000	462000	462000	462000	462000	462000	462000	462000	462000
Incremental R&D cost	-	-	-	-	-	-	-	-	-
After tax cash flow	10988654	12239100	13614590	15127629	16791972	18622749	20636604	21522700	22444240
Present value of after tax cash flow	10209657	10565323	10919545	11272848	11626125	11979639	12334025	11951709	11579901
Net present value

Incremental Cash Flow Calculation Year 10 - 20

	10	11	12	13	14	15	16	17	18	19	20
	10562	10984	11423	11880	12356	12850
	21450	21450	21450	21450	21450	21450	21450	21450	21450	21450	21450
	19305	19305	19305	19305	19305	19305	19305	19305	19305	19305	19305
	16850	16850	16850	16850	16850	16850	16850	16850	16850	16850	16850
	-	-	-	-	-	-	-	-	-	-	-
	1410000	1410000	1410000	1410000	1410000	1410000	1410000	1410000	1410000	1410000	1410000
	1645651	1693078	1742401	1793697	1847044	1902526	1960227	2020236	2082646	2147552	2215054
	462000	462000	462000	462000	462000	462000	462000	462000	462000	462000	462000
	-	-	-	-	-	-	-	-	-	-	-
	23402641	24399379	25435986	26514058	27635252	28801294	30013978	31275169	32586808	33950912	35369580
	11218414	10867059	10525640	10193956	9871807	9558988	9255292	8960513	8674445	8396881	8127615
Net Present Value											208,089,482

Exhibit 4

Net Present Value: Sail Boats

Land	-1,650,000
Building	-6,850,000
Equipment	-13,350,000
1CCA tax shield - building	917,790
2CCA tax shield - equipment	3,703,334
3Issuance Cost	-193,314
Change in networking Capital	-730,000
Incremental cash flows	132,014,683
4Overhaul	-1,730,533
5CCA tax shield - overhaul	480,055
6Sale of land	589,243
7Capital Gain - land	-36,394
8Sale of building	422,869
9Lost CCA tax shield building	-56,658
Sale of equipment	-
Lost CCA tax shield equipment	-
10Change in networking Capital	168,685
Net Present Value	113,699,760

1CCA tax shield – building:

(6,850,000)(.35)(.05/(.05+.076))((2+.076)/2(1+.076)) = 917,790

2CCA tax shield – equipment:

(13,350,000)(.35)(.05/(.05+.076))((2+.076)/2(1+.076)) = 3,703,334

3Insuance costs:

Weighted average insuance cost = (.04)(.0325) = .013 or 1.3%

(Total capital to raise)(1-Insuance costs) = (Total capital needed)

8Sale of building

(1,830,000)/(1+.076)20 = 422,869

9Lost CCA tax shield – building:

(1,830,000)(.35) (.05/(.05+.076))((2+.076)/2(1+.076)) =245,191

(245,191)/(1+.076)20 = 56,658

10Change in net working capital:

(730,000)/(1+.076)20 = 168,658

Incremental Cash Flow Calculation Year 1 - 9

	1	2	3	4	5	6	7	8	9
Sale in Units	12100	13915	16002	18403	21263	24337	25311	26323	27376
Sales Prices(retailer)	3500	3500	3500	3500	3500	3500	3500	3500	3500
Unit Cost	2590	2590	2590	2590	2590	2590	2590	2590	2590
R&D Costs	-	-	-	-	-	-	-	-	-
Incremental Non traceable factory cost	1050000	1050000	1050000	1050000	1050000	1050000	1050000	1050000	1050000
Incremental selling cost	550550	633133	728102	837318	962915	1107353	1151647	1197713	1245621
Incremental administration cost	320000	320000	320000	320000	320000	320000	320000	320000	320000
Incremental R&D cost	117000	117000	117000	117000	117000	117000	117000	117000	117000
After tax cash flow	5832743	6852636	8025514	9374324	10925455	12709256	13256288	13825202	14416872
Present value of after tax cash flow	5420764	5918793	6442228	6993440	7574922	8189295	7938456	7694374	7456931
Net present value

Incremental Cash Flow Calculation Year 10 - 20

	10	11	12	13	14	15	16	17	18	19	20
	28471	10984	11423	11880	12356	12850	36025	37466	38965	40524	42145
	3500	3500	3500	3500	3500	3500	3500	3500	3500	3500	3500
	2590	2590	2590	2590	2590	2590	2590	2590	2590	2590	2590
	-	16850	16850	16850	16850	16850	16850	16850	16850	16850	16850
	1050000	-	-	-	-	-	-	-	-	-	-
	1295456	1410000	1410000	1410000	1410000	1410000	1410000	1410000	1410000	1410000	1410000
	320000	1693078	1742401	1793697	1847044	1902526	1960227	2020236	2082646	2147552	2215054
	117000	462000	462000	462000	462000	462000	462000	462000	462000	462000	462000
	15032209	24399379	25435986	26514058	27635252	28801294	30013978	31275169	32586808	33950912	35369580
	7226035	10867059	10525640	10193956	9871807	9558988	9255292	8960513	8674445	8396881	8127615
Net Present Value											132014683