Mini Case Ch. 11

Shrieves Casting Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by Sidney Johnson, a recently graduated MBA. The production line would be set up in unused space in Shrievess main plant. The machinerys invoice price would be approximately $200,000, another $10,000 in shipping charges would be required, and it would cost an additional $30,000 to install the equipment. The machinery has an economic life of 4 years, and Shrieves has obtained a special tax ruling that places the equipment in the MACRS 3-year class. The machinery is expected to have a salvage value of $25,000 after 4 years of use.

The new line would generate incremental sales of 1,250 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 in the first year. The sales price and cost are both expected to increase by 3 percent per year due to inflation.

Further, to handle the new line, the firms net operating working capital would have to increase by an amount equal to 12 percent of sales revenues. The firms tax rate is 25 percent, and its overall weighted average cost of capital, which is the risk-adjusted cost of capital for an average project r, is 10%.

E. estimate the required net operating working capital (NOWC) for each year and the cash flow due to changes in NOWC.