CASE STUDY- Grande Company

The case will test the students understanding of the techniques as well as the qualitative aspects of risk and return decision-making and financial management decision as a whole.

Grande Company is a commercial printer company that involved in printing high quality booklets, advertising brochures and other direct mail pieces. The firms major clients are advertising agencies based in Malaysia. The typical job is characterized by high quality and production runs of more than 50,000 units. Grande has not been able to compete effectively with larger printers because of its existing older, inefficient presses. The firm is currently having problems cost effectively meeting run length requirements as well as meeting quality standards.

Therefore, Grande Company faced with a replacement decision in which two mutually exclusive projects have been proposed. In order to ensure that the company can compete efficiently with their competitors, Grandes General Manager has proposed the purchase of two large laser printers designed for long and high-quality runs. The purchase of a new printer would expected to reduce its cost of labour as well as price to the client, putting the firm in a more competitive position. The key financial characteristics of the old press and of the two proposed presses are summarized as below:

Old Laser Printer Originally purchased three years ago at an installed cost of $ 400,000, it is being depreciated under MACRS using a 5-year recovery period. The old press has a remaining economic life of 5 years. It can be sold today to net $ 420,000 before taxes; if it is retained, it can be sold to net $ 150,000 before taxes at the end of year 5. Earnings before depreciation, interest and taxes for the present printer are expected to be $120,000 for each of the successive 5 years.

Laser Printer 1 This highly automated press can be purchased for $ 830,000 and will require $ 40,000 installation costs. It will be depreciated under MACRS using a 5-year recovery period. At the end of the 5years, the machine could be sold to net $ 400,000 before taxes. If this machine is acquired, it is anticipated that the following current account changes would result an increase in cash $25,400, account payables will increase $35,000, inventories will decrease $20,000 and account receivables will increase $120,000. For this proposed printer, the expected earnings before depreciation, interest and taxes for each of the next 5 years are $250,000, $270,000, $300,000, $330,000 and $370,000 respectively.

Laser Printer II This press is not as sophisticated as laser printer I. It costs $ 640,000 and requires $20,000 in installation costs. It will be depreciated under MACRS using a 5-year recovery period. At the end of five years, it can be sold to net $ 330,000 before taxes. For this proposed printer, the earnings before depreciation, interest and taxes for each of the next 5 years are expected to be $210,000 for each of the next 5 years. Acquisition of this press will have no effect on the firms net working capital investment.

The firm is subject to a 40%tax rate. The firms cost of capital, applicable to the proposed replacement is 14%.

Required:

1. For each of the two proposed replacement printers, calculate:

a) Initial Investment for Grande Company

b) Operating Cash Inflows (be sure to consider the depreciation in year 6)

c) Terminal Cash Flow at the end of year 5

(12 Marks)

2. Using the data developed in part a), find and depict on a time line the relevant cash flow stream associated with each of the two proposed replacement presses, assuming that each is terminated at the end of 5 years. (6 Marks)

3. Using the data developed in Question 2:

a) Determine the payback period (Note: for year 5, use only the operating cash inflows-that is, exclude terminal cash flowwhen making this calculation) for each alternative.

b) Determine net present value of the proposed printers.

c) Determine the Internal Rate of Return of the proposals.

(12 Marks)