FINC 600: CAPITAL BUDGETING AT BENT CREEK


DEPARTMENT OF FINANCE

 FINC 600 FINANCIAL MANAGEMENT

 CAPITAL BUDGETING AT BENT CREEK

Bent Creek Company is considering launching a product line extension – a “new and improved” version with enhanced product features and environmentally friendly packaging.
Below are key estimates and assumptions associated with the project:

Project life (in years) 4
Initial cost of equipment  $ 2,300,000
Initial Increase in Inventory  $ 50,000
Initial Increase in accounts receivables  $ 120,000
Initial Increase in accounts payables  $ 30,000
Gross sales from the new product line in year 1  $ 1,500,000
Gross sales increase after year 1 (per year) 7%
Operating costs excluding cost of launching (as a% of  gross sales) 25%
Launch costs in year 1  $ 75,000
Market research cost prior to the start of the project  $ 60,000
Inflation estimate per year (included in sales) 3%
Weighted average cost of capital 12%
Marginal corporate income tax rate 35%

 

Net working capital will be 10% of sales starting year 1. The new equipment is depreciated on a straight line basis over the life of the project. It is estimated that the new product will result in cannibalization of existing sales by an amount of $75,000 per year. The new equipment is estimated to have a salvage value of $150,000 in 4 years.

 

Create a spreadsheet solution to this problem and answer the following questions.

  1. Using the above information (base case scenario), calculate the criteria needed to determine the project feasibility (Payback, NPV, IRR, MIRR, PI).

 

  1. Based on the above feasibility analysis, would you recommend the new product line extension? Why?

 

  1. What is the risk associated with this project? How do you measure and evaluate that risk?

 

  1. What do you know for certain about your forecast? How often will assumptions change?

 

  1. What are the key value “drivers” of this project?

 

  1. Perform the following sensitivity analyses:

Scenario I:  A decline in sales by 10%

Scenario II: An increase in equipment cost by 10%

Scenario III: Increase in operating costs from 25% to 30% of sales

Scenario IV: Increase in WACC from 12% to 14%

Scenario V:  Combined I through IV.

 

  1. Are Economic Value Added (EVA) and ROIC metrics appropriate in this case?

 

  1. The company has hired a financial consultant to advise the company on pricing the new product. After some analysis he concludes that the demand function is given by Q = 500,000-25,000*P. here Q is quantity and P is price. What price should the firm charge to break even (i.e. zero NPV)?
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