Analyze and compare/recommend a project using the tools and approaches we have covered in class this term. You will work in groups of 4 to 5 students to evaluate and compare two alternative cashflows, using base data provided for the project. You will be expected to compare both projects using NPV, IRR, and breakeven, then to make and defend a clear recommendation for the project to be selected.

You are an engineer with World Wide Widgets Inc. (WWW). This company produces a competitive widget product but is seeking to cut costs and expand their profits. They have identified two mutually exclusive projects as possible ways to accomplish these goals.

Alternative Projects

Project A

WWW will invest considerable amounts into expanding their current widget production capacity. This will involve the construction of a large extension to their existing factory, as well as the purchase of new production equipment, the training of new production workers, and the operation of this new capacity across the next 20 years.

Project A Costs and Cashflow Elements - Money Out

• The construction of the new factory extension will cost an estimated $8.7 million and will take place in years 1 and 2, with total costs spread evenly across both years.

• The new equipment needed to expand production will cost an estimated $6.1 million, which will occur in year 2.

• Training for new staff will cost a projected $645,000 in year 2

• Maintenance on the building and new equipment will cost an estimated $300,000 annually, but is forecast to rise by $12,000 each year for the next 20 years.

• Current non-operating costs and revenues are expected to remain unchanged and can be ignored.

Project A Costs and Cashflow Elements - Money In

• WWW currently produces 25,000 widgets annually, at an Average Total Cost (ATC) per widget of $652 and a market price of $840 per widget. WWW is a price searcher, so they have been holding production to the level at which they get the lowest ATC

• The marketing department is convinced that there would be much larger demand if they could lower the price to $680, but current costs prevent that. Current sales are at 25,000 widgets per year.

• Figure 1 shows the projected ATC curve for WWW if they go ahead with Project A. Figure 2 shows the demand curve for Widgets in the current market.

Project B

WWW has an opportunity to buy a nearby competitor Amazing Widgets Inc (AW) who currently produces a widget very similar to WWW's product. The deal would be an outright purchase of the company, with all its current equipment, facilities, employees, assets and liabilities, and customer accounts.

Project B Costs and Cashflow Elements - Money Out

• AW has asked a price of $121 million, based on their assets, reputation, and annual total income/free cash flow. This number may be negotiable. If WWW did buy AW, the price would be due in year 1.

• AW's current production capacity is similar to WWW's and it would require an additional investment of $6 million, at least, to expand it to 150% of capacity. The cost to go beyond that is very difficult to estimate at this point.

Project B Costs and Cashflow Elements - Money In

• AW currently sells 23,000 widgets annually, at an ATC of $671 and a market price of $850.

• AW has $1.7 million in non-operating fixed costs (The CEO's salary, the accounting department, etc) which could be eliminated if they are bought by WWW.

• An additional cost savings of $17 per widget could be obtained on AW's production at any level by combining raw materials orders with WWW's current orders.

• Figure 3 shows AW's ATC curve at current levels and at the 150% expanded level.

 Your Task 

You must compare both projects, using NPV, IRR and simple breakeven using a cumulative cash flow curve. Then you must recommend one project, based on your overall analysis.

Project A

• Lay out the complete cashflow curve. Start with money out, including initial costs and ongoing maintenance costs.

• Calculate money in (annual net income) using the ATC cost curve from Figure 1 and the demand curve from Figure 2 to determine the best choice for production volume. Once you select production volume from the ATC curve, you will know the cost. Look at the Demand curve in Figure 2 to see what price you can charge to get to that level of demand.

• Using the figures you have developed for Money in and Money out across 20 years, lay out the complete cashflow and calculate NPV and IRR, using the WACC rate provided. (You can use the spreadsheet tool I gave you for this.)

• Develop a cumulative cashflow curve across the 20 years and show simple breakeven and maximum cost points.

• Assess risks and describe how you can manage them/mitigate them.

• Consider intangibles that cannot be included in the cashflow and assess how important they are to this project/decision.

Project B

• Using the data on AW's production volume along with costs and prices per units, calculate AW's actual NPV using the WACC rate for WWW. Remember that this is for an indefinite period so use the in-perpetuity model, not the TVM approach.

• Lay out the cashflow for a 20 year period for both the $121 million asking price and your NPV from the step above. Calculate an NPV and IRR for both options. (You can use the spreadsheet tool I gave you for this.)

• Lay out and calculate a third cashflow at your NPV value from the first step and including the option to expand production by an additional 50%, but reflecting the $17/per widget savings from the consolidation of raw materials orders and the elimination of the $1.7 million in fixed costs. Be sure to spread these fixed costs over the total production at AW (150% of the original 23,000 widgets per year.) to get the new ATC cost.

• Develop a cumulative cashflow curve across the 20 years and show simple breakeven and maximum cost points for the cashflow you think most likely for Project B.

• Assess risks and describe how you can manage them/mitigate them.

• Consider intangibles that cannot be included in the cashflow and assess how important they are to this project/decision.

Comparison and Recommendations

Compare both projects based on NPV, IRR, Breakeven, risks, and intangibles and make your recommendation to management as to which project should be selected. Explain why. Be sure to include the impacts of tax on money in. You can ignore the impact of depreciation.

Background Data

• WWW's WACC is 4% and is expected to remain constant for the next 20 years.

• WWW's MARR (hurdle Rate) is currently 12%

• WWW's corporate taxes are 21%

• The expected average inflation rate for the next 20 years is 2%

Answer rating: 100% (QA)

Analyzing Project A B for World Wide Widgets Inc This analysis will compare Project A capacity expansion and Project B acquisition for WWW using NPVIRRbreakeven analysisrisk assessmentand intangiblesF... View the full answer