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.
- Using the above information (base case scenario), calculate the criteria needed to determine the project feasibility (Payback, NPV, IRR, MIRR, PI).
- Based on the above feasibility analysis, would you recommend the new product line extension? Why?
- What is the risk associated with this project? How do you measure and evaluate that risk?
- What do you know for certain about your forecast? How often will assumptions change?
- What are the key value “drivers” of this project?
- 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.
- Are Economic Value Added (EVA) and ROIC metrics appropriate in this case?
- 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)?