advanced Finance case study

The Baldwin Company, originally established in 1965 to make footballs, is now a leading producer of tennis balls, baseballs, footballs, and golf balls. Baldwin management has sought opportunities in whatever businesses seem to have potential for cash flow. Recently W.C. Meadows, Vice President of the Baldwin Company, identified another segment of the sports ball market that looked promising and that he felt was not adequately served by larger manufacturers. That market was for brightly colored bowling balls, and he believed many bowlers valued appearance and style above performance. He also believed that it would be difficult for competitors to take advantage of the opportunity because of both Baldwin’s cost advantages and its highly developed marketing skills.

After investigated the marketing potential of brightly colored bowling balls, The Baldwin Company is now considering investing in a machine to produce bowling balls. The bowling balls would be manufactured in a building owned by the firm and located near Bakersfield. This building, which is vacant, and the land can be sold for $150,000 after taxes.

Working with his staff, Meadows is preparing an analysis of the proposed new product. He summarizes his findings as follows:

The cost of the bowling ball machine is $100,000. The machine has estimated market value at end of five years of $30,000.

Production by year during the five-year life of the machine is expected as follows: 5,000 units, 8,000 units, 12,000 units, 10,000 units, and 6,000 units. The price of bowling balls in the first year will be $20. The bowling balls market is highly competitive, so Meadows believes that the price of bowling balls will increase at only2 percent per year, as compared to the anticipated general inflation rate of 5 percent. Conversely, the plastic used to produce bowling balls is rapidly becoming more expensive. Because of this, production cash outflows are expected to grow at 10 percent per year. First-year production costs will be $10 per unit. Meadows has determined, based on Baldwin’s taxable income that the appropriate incremental corporate tax rate in the bowling ball project is 34 percent.

Like any manufacturing firm, Baldwin finds that it must maintain an investment in working capital. It will purchase raw materials before production and sale, giving rise to an investment in inventory. It will maintain cash as a buffer against unforeseen expenditures. And, its credit sales will generate accounts receivable. Management determines that an immediate investment in the different items of working capital of $10,000 is required. Working capital is forecast to rise in the early years of the project but to fall to $0 by the project’s end.

Projections based on these assumptions and Meadows’ analysis appears in the attached excel file.

Baldwin's Bowling Ball Project : the worksheet for cash flows

year 012345

Investment

Bowling ball machine-10021.772Recovery Period Class (year)

Depreciationyear1234567891011

Accumulated Depreciation30.3330.4440.1480.074

Machine book value50.20.320.1920.1150.1150.058

Opportunity cost-15015070.1430.2450.1750.1250.0890.0890.0890.045

Net working Capital101016.3224.9721.220100.10.180.1440.1150.0920.0740.0660.0660.0660.0660.033

change in net working Capital-10

total cash flow of investment 4+8+10year

sales 12345

units5812106(ooo)

price20

units cost10

costs