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Fin370 week 3 team assignment caledonia products integrative problems

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Caledonia Products

Calculating Free Cash Flow and Project Valuation

It’s been two months since you took a position as an assistant financial analyst at Caledonia Products. Although your boss has been pleased with your work, he is still a bit hesitant about unleashing you without supervision. Your next assignment involves both the calculation of the cash flows associated with a new investment under consideration and the evaluation of several mutually exclusive projects. Given your lack of tenure at Caledonia, you have been asked not only to provide a recommendation, but also to respond to a number of questions aimed at judging your understanding of the capital-budgeting process. The memorandum you received outlining your assignment follows:

To: The Assistant Financial Analyst

From: Mr. V. Morrison, CEO, Caledonia Products

Re: Cash Flow Analysis and Capital Rationing

We are considering the introduction of a new product. Currently we are in the 34% tax bracket with a 15% discount rate. This project is expected to last five years and then, because this is somewhat of a fad project, it will be terminated. The following information describes the new project:

 

Cost of new plant and equipment: $ 7,900,000
Shipping and installation costs: $ 100,000
Unit sales:

 

 

Year Units Sold
1 70,000
2 120,000
3 140,000
4 80,000
5 60,000

 

 

Sales price per unit: $300/unit in years 1–4 and $260/unit in year 5.
Variable cost per unit: $180/unit
Annual fixed costs: $200,000 per year

 

Working capital requirements: There will be an initial working capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will be equal to 10% of the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5.

Depreciation method: Straight-line over 5 years assuming the plant and equipment have no salvage value after 5 years.

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