Managerial Finance

Details:

Iron Ore What? (IOW) Casting Company is considering adding a new line to its product mix. Sydney Johnson, a recently minted MBA, will be conducting the capital budgeting analysis. The new production line would be set up in unused space in IOW's main plant. The machinery invoice price totals approximately $250,000, with another $20,000 in shipping charges and S30,000 to install the equipment, for a total requirement estimated at $300,000. The machinery has an economic life of 4 years, and IOW has obtained a special tax ruling that places the equipment in the Modified Accelerated Cost Recovery System (MACRS) 3-year class. After 4 years of use the machinery is expected to have a salvage value of s25,000.

The new product line would generate incremental sales of 1,350 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 each in the first year. The sales price and cost are expected to increase by 3% per year due to inflation. Further, to handle the new line, the firm's net working capital would have to increase by an amount equal to l5o/o of sales revenues. The firm's tax rate is 40yo, and its overall weighted average cost of capital is l2o/o.

1. Calculate and provide the annual sales revenues and costs (other than depreciation). Why is it important to include inflation when estimating cash flows?

2. Construct 4 yexs of annual incremental operating cash flow statements for IOW Casting Company. Estimate the required net working capital for each ylffi, and the cash flow due to investments in net working capital. Calculate the after-tax salvage cash flow.

3. Calculate the net cash flows for each of the 4 years. Based on these cash flows, what are the project's NPV, IRR, MIRR, PI, payback, and discounted payback? Do these indicators suggest the project should be undertaken? Explain.

4. What does the term'orisk" 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 subj ective, j udgmental estimates? Provide your rationale.

5. Describes sensitivity analysis and discuss a) its primary weakness; and b) its primary usefulness? For the IOW project, perform a sensitivity analysis on