re: caledonia products

Project Description:

it’s been four months since you took a position as an assistant finacial analyst at caledonia products. during that time, you’ve had a promotionand you are now working as a special assistant for capital budgeting, reporting directly to the ceo. your latest task involves the analysis of several risky projects. because this is your first task dealing with risky analysis, you have been asked not only to provide a recommendation on the projects in question, but also to respond to a number of questions aimed at judging your understanding of risk analysis and captial budgeting. the memorandum you received outlining your assingment follows

to: the special assistant for capital budgeting
from: mr. v. morrison, ceo, caledonia products
re: capital budgeting and risk analysis
provide a written response to the following questions:
1. now the management is comfortable with your skills your boss would like you to look at a new project. this new project involves the purchase of a new plasma cutting tool that can be used in its metal works division. the product manufactured using the new technology are expected to sell for an average price of $300 per unit, and the company analyst performing the analysis expects the firm can sell $20,000 units per year at this price for a period of five years. to get into this business will require the purchase of a $2 million piece of equipment that has a residual or salvage value in five years of $200,000. in addition the firm expects to have to invest an additional $300,000 in working capital to support the new business. other pertinent information concerning the business venture is as follows:

initial cost of equipment.................................... $2,000,000
project and equipment life...................... .............5 years
salvage value of equipment................................$200,000
working capital requirement .............................. $300,000
depreciation method............................................straight line
depreciation expense...........................................$360,000
discount rate or required rate of return ................12%
tax rate ....................................................... 30%

in addition, estimates for unit sales, selling prices variable cost per unit, and fixed cash operating expenses for the base-case, worst case, and best-case scenarios are as follows


...................................................... expected or base –case......................worst case......................best-case
unit sales................................................... 20,000........................................15,000............................25,000
price per unit.............................................. $300...........................................250................................$330
variable cost per unit..................................(200)...........................................(210)...............................(180)
cash fixed cost per year............................(500,000)...................................(450,000)........................(350,000)
depreciation expense ................................$360,000....................................$360,000.........................360,000


a. estimate the cash flows for the investment under the listed base-case or expected value assumptions. calculate the project npv for these cash flows.
b. evaluate the npv of the investment under the worst-case assumptions.
c. evaluate the npv of the investment under the best-case assumption.
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Project Stats: Edited

Price Type: Fixed

Project Budget: $0 to $10
Completed
Total Proposals: 11
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