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Integrative Case 5 Lasting Impressions Company Lasting impressions (LI) Company is a medium-sized commercial printer of promotional advertising brochures, booklets, and other direct mail pieces. The firm's major clients are ad agencies based in New York and Chicago The typical job is characterized by high quality and production runs of more than 50,000 units LI has not been able to compete affectively with larger printers because of its existing older inefficient presses. The firm is currently having problems meeting run length requirements as well as mooting quality standards in a cost-effective manner The general manager has proposed the purchase of one of two large, six color presses designed for long high quality runs The purchase of a new press would enable Lito reduce its cost of labor and therefore the 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 we summarized in what follows Old press Oniginly purchased 3 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 remaining economice of 5 years it can be sold today to net $420,000 before taxes, it is retained it can be sold to net 150,000 before him at the end of 5 years Pross A This highly automated press can be purchased for $330 000 and will require 540,000 in installation costs it will be depreciated under MACRS o 5-year recovery penod At the end of the years, the machine could be sold to net 5400,000 before tages it this machine is acqued, et is anticipated that the current account chunges shown in the following table would result Old press Originally purchased 3 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, a can be sold to net $150,000 before taxes at the end of 5 years Pross A This highly automated press can be purchased for $830,000 and will require S40,000 in installation costs. It will be depreciated under MACRS using #5 you recovery period Al the end of the 5 years, the machine could be sold to not $400,000 before taxes if this machine is acquired, it is anticipated that the current account changes shown in the following table would result Cash 5 25.400 Accounts receivable 120.000 werhones - 20.000 Accounts payable +35.000 Press & Truspress is not as sophisticated as press A It costs $640,000 and requires $20.000 in installation costs It will be depreciated under MACRS using a 5 yecovery period At the end of 5 years, it can be sold to net $330,000 before taxes Acquisition of this press will have no effect on the firm's net working capital investment Pross B This press is not as sophisticated as press A 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 5 years, it can be sold to net $330,000 before taxes Acquisition of this press will have no effect on the firm's net working capital investment The timestimates that its earnings before depreciation, interest, and taxes with the old press and with press A or press for each of the 5 years would be as shown in the table at the top of the next page The firm is subject to a 40% tax rate The firm's cost of capital, applicable to the proposed replacement is 14% Earnings before Depreciation, Interest, and Taxes for lasting Impressions Company's Presses Year Old press Press A Press B 1 $120.000 $260.000 5210,000 120,000 270.000 210.000 2 120.000 300 000 210.000 120,000 330 000 210,000 120.000 370.000 210 000 Earnings before Depreciation, Interest, and Taxes for Lasting Impressions Company's Presses Year Old press Press A Press B 1 $120,000 $250,000 $210,000 120,000 270,000 210,000 120,000 300.000 210,000 4 120.000 330,000 210,000 5 120.000 370.000 210.000 For each of the two proposed replacement presses, determine (1) Initial investment (2) Operating cash inflows. (Note: Be sure to consider the depreciation in year 6) (3) Terminal cash flow. (Note: This is at the end of year 5.) 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 Using the data developed in part b, apply each of the following decision techniques (1) Payback period (Note For year 5, use only the operating cash inflows-that is exclude terminal cash flow-when making this calculation) (2) Net present value (NPV) (3) Internal rate of return (IRR) Draw net present value profiles for the two replacement presses on the same set of axes and discuss conflicting rankings of the two presses, if any, resulting from use of NPV and IRR decision techniques Recommend which if either of the presses the firm should acquire if the firm has (1) unlimited funds or (2) capital rationing 1 The operating cash inflows associated with press A are characterized as very risky in contrast to the low-risk operating cash inflows of press B What impact does that have on your recommendation? Integrative Case 5 Lasting Impressions Company Lasting impressions (LI) Company is a medium-sized commercial printer of promotional advertising brochures, booklets, and other direct mail pieces. The firm's major clients are ad agencies based in New York and Chicago The typical job is characterized by high quality and production runs of more than 50,000 units LI has not been able to compete affectively with larger printers because of its existing older inefficient presses. The firm is currently having problems meeting run length requirements as well as mooting quality standards in a cost-effective manner The general manager has proposed the purchase of one of two large, six color presses designed for long high quality runs The purchase of a new press would enable Lito reduce its cost of labor and therefore the 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 we summarized in what follows Old press Oniginly purchased 3 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 remaining economice of 5 years it can be sold today to net $420,000 before taxes, it is retained it can be sold to net 150,000 before him at the end of 5 years Pross A This highly automated press can be purchased for $330 000 and will require 540,000 in installation costs it will be depreciated under MACRS o 5-year recovery penod At the end of the years, the machine could be sold to net 5400,000 before tages it this machine is acqued, et is anticipated that the current account chunges shown in the following table would result Old press Originally purchased 3 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, a can be sold to net $150,000 before taxes at the end of 5 years Pross A This highly automated press can be purchased for $830,000 and will require S40,000 in installation costs. It will be depreciated under MACRS using #5 you recovery period Al the end of the 5 years, the machine could be sold to not $400,000 before taxes if this machine is acquired, it is anticipated that the current account changes shown in the following table would result Cash 5 25.400 Accounts receivable 120.000 werhones - 20.000 Accounts payable +35.000 Press & Truspress is not as sophisticated as press A It costs $640,000 and requires $20.000 in installation costs It will be depreciated under MACRS using a 5 yecovery period At the end of 5 years, it can be sold to net $330,000 before taxes Acquisition of this press will have no effect on the firm's net working capital investment Pross B This press is not as sophisticated as press A 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 5 years, it can be sold to net $330,000 before taxes Acquisition of this press will have no effect on the firm's net working capital investment The timestimates that its earnings before depreciation, interest, and taxes with the old press and with press A or press for each of the 5 years would be as shown in the table at the top of the next page The firm is subject to a 40% tax rate The firm's cost of capital, applicable to the proposed replacement is 14% Earnings before Depreciation, Interest, and Taxes for lasting Impressions Company's Presses Year Old press Press A Press B 1 $120.000 $260.000 5210,000 120,000 270.000 210.000 2 120.000 300 000 210.000 120,000 330 000 210,000 120.000 370.000 210 000 Earnings before Depreciation, Interest, and Taxes for Lasting Impressions Company's Presses Year Old press Press A Press B 1 $120,000 $250,000 $210,000 120,000 270,000 210,000 120,000 300.000 210,000 4 120.000 330,000 210,000 5 120.000 370.000 210.000 For each of the two proposed replacement presses, determine (1) Initial investment (2) Operating cash inflows. (Note: Be sure to consider the depreciation in year 6) (3) Terminal cash flow. (Note: This is at the end of year 5.) 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 Using the data developed in part b, apply each of the following decision techniques (1) Payback period (Note For year 5, use only the operating cash inflows-that is exclude terminal cash flow-when making this calculation) (2) Net present value (NPV) (3) Internal rate of return (IRR) Draw net present value profiles for the two replacement presses on the same set of axes and discuss conflicting rankings of the two presses, if any, resulting from use of NPV and IRR decision techniques Recommend which if either of the presses the firm should acquire if the firm has (1) unlimited funds or (2) capital rationing 1 The operating cash inflows associated with press A are characterized as very risky in contrast to the low-risk operating cash inflows of press B What impact does that have on your recommendation