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 the main plant. The

machinery$$s invoice price would be approximately $$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

$3\%$ per year due to inflation. Further, to handle the new line, the firm$$s net working

capital would have to increase by an amount equal to $12\%$ of sales revenues. The firm$$s tax

rate is $40\%,$ and its overall weighted average cost of capital, which is the risk$-$adjusted cost

of capital for an average project $($r$),$ is $10\%.$

a$.$ Define $$incremental cash flow.$$

$(1)$ Should you subtract interest expense or dividends when calculating project cash

flow?

$(2)$ Suppose the firm spent $$100,000$ last year to rehabilitate the production line site.

Should this be included in the analysis? Explain.

$(3)$ Now assume the plant space could be leased out to another firm at $$25,000$ per

year. Should this be included in the analysis? If so$,$ how?

$(4)$ Finally, assume that the new product line is expected to decrease sales of the firm$$s

other lines by $$50,000$ per year. Should this be considered in the analysis? If so$,$ how?

b$.$ Disregard the assumptions in Part a$.$ What is the depreciable basis? What are the

annual depreciation expenses?

c$.$ Calculate the annual sales revenues and costs $($other than depreciation$).$ Why is it

important to include inflation when estimating cash flows?

d$.$ Construct annual incremental operating cash flow statements.

e$.$ Estimate the required net working capital for each year and the cash flow due to

investments in net working capital.

f$.$ Calculate the after$-$tax salvage cash flow.

g$.$ Calculate the net cash flows for each year. Based on these cash flows and the average

project cost of capital, what are the project$$s NPV$,$ IRR, MIRR, PI$,$ payback, and

discounted payback? Do these indicators suggest that the project should be

undertaken