Question: read the project and solve

WWW will invest considerable amounts into expanding its 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, beginning at the end of year 2, but is forecast to rise by $12,000 each year for the next 18 years, from year 2 to year 20.

• 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.

Task

Make sure using NPV, IRR and simple breakeven using a cumulative cash flow curve.

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. Remember that the additional widgets can be produced beginning in year 3.

• 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.

• 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. You might decide to add a risk premium to the WACC rate. If so, explain this to me.

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