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John Crockett Furniture Company is considering adding a new line to its product mix




John Crockett Furniture Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by Joan Samuel, a recently graduated finance MBA. The production line would be set up in unused space in Crockett's 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. Further, the firm's inventories would have to be increased by $25,000 to handle the new line, but its accounts payable would rise by $5,000. The machinery has an economic life of 4 years, and Crockett 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 $125,000 in incremental net revenues (before taxes and excluding depreciation) in each of the next 4 years. The firm's tax rate is 40% and its overall weighted average cost of capital is 10%.;a)Construct the project's cash flows over its 4 year life. Based on these cash flows, what are the project's NPV and IRR? Do these indicators suggest that the project should be undertaken?;b)Assume now that the project is a replacement project rather than a new or expansion, project. Describe how the analysis would differ for a replacement project.;c)Explain what is meant by cash flow estimation bias. What are some steps that Crockett's management could take to eliminate the incentives for bias in the decision process?;d)In an unrelated analysis, Joan was asked to choose between the following two mutually exclusive projects;Expected Net Cash Flow;year Project S Project L;0 -100,000 -100,000;1 60,000 33,500;2 60,000 33,500;3 - 33,500;4 - 33,500;The project provides a necessary service, so whichever one is selected is expected to be repeated into the foreseeable future. Both projects have a 10% cost of capital.;(1)what is each project's initial NPV without replication? Can you use the information to determine which project should be chosen? Explain.;(2)Now apply the replacement chain approach to determine the project's extended NPVs. Which project should be chosen? Explain.;(3) Repeat the analysis using the equivalent annual annuity approach. Which project should be chosen? Explain.


Paper#21449 | Written in 18-Jul-2015

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