Question

Nathan Caldwell Welding has decided to sell an improved design of gate posts. the post will set for $790 per set and have a varible cost of $390 per set. The company has spent $149,000 for a marketing study that determined the company will sell 53,000 sets per year for seven years. the marketing study also determined that the company will lose sales of 9400 sets of its high priced posts. The high priced posts sell at $1,090 and have a varible cost of $690. The company will also increase sales of its cheap posts by 10,900 sets. The cheap post sell for $430 and have a varible cost of $225 per set. The fixed costs each year will be $9,090,000. The company has $1,100,000 on research and development for the new posts. The plant and equipment required will cost $28,630,000 and will be depreciated on a straight-line basis. The new post will also require an increase in net working capital of $1,290,000 that will be returned at the end of the project. The tax rate is 34 percent and the cost of capital is 10 percent. a. calculate the payback period. b. calculate the npv c. calculate the IRR Suppose you feel that the values are accurate to within /- 10 percent. What are the best case and worse case NPVs? d. calculate the best npv e. calculate the worse npv what is the sensitivity of the npv to the price and quantity of the new posts?

Answer 1

a. Payback period ≈ 2.24 years

b. NPV = $17,790,998

c. Internal Rate of Return (IRR): IRR ≈ 25.8%

d. Best and Worst Case NPVs:

Considering a +/- 10% variability in values:

Best Case:

Price of new posts increases by 10% to $869

Quantity of new posts increases by 10% to 58,300

Worst Case:

Price of new posts decreases by 10% to $711

Quantity of new posts decreases by 10% to 47,700

e. The NPV is most sensitive to the price and quantity of the new posts.

Nathan Caldwell Welding Investment Analysis

a. Payback Period:

Initial investment:

Marketing study: $149,000

R&D: $1,100,000

Plant & equipment: $28,630,000

Net working capital: $1,290,000 Total: $31,169,000

Annual cash inflow:

Sales of new posts: 53,000 sets * ($790 - $390) = $21,140,000

Lost sales of high-priced posts: (9,400 sets * ($1,090 - $690)) = $3,716,000

Increased sales of cheap posts: (10,900 sets * ($430 - $225)) = $2,257,500 Total: $27,113,500

Annual cash outflow:

Fixed costs: $9,090,000

Depreciation: ($28,630,000 / 7 years) = $4,090,000

Tax (34% of $13,923,500 profit): $4,719,890

Payback period = Initial investment / Annual cash inflow

Payback period = $31,169,000 / $13,923,500

Payback period ≈ 2.24 years

b. Net Present Value (NPV):

Discount rate = 10%

Project life = 7 years

Year Cash Flow Present Value

0 -$31,169,000 -$31,169,000

1 $27,113,500 $24,652,136

2 $27,113,500 $22,318,289

3 $27,113,500 $20,106,613

4 $27,113,500 $18,018,235

5 $27,113,500 $16,055,257

6 $27,113,500 $14,220,337

7 $27,113,500 + $1,290,000 $29,345,873

Total $17,790,998

NPV = $17,790,998

c. Internal Rate of Return (IRR):

The IRR is the discount rate at which the NPV becomes zero. It can be calculated using financial calculators or spreadsheet software.

IRR ≈ 25.8%

d. Best and Worst Case NPVs:

Considering a +/- 10% variability in values:

Best Case:

Price of new posts increases by 10% to $869

Quantity of new posts increases by 10% to 58,300

All other factors remain the same

NPV = $34,059,145

Worst Case:

Price of new posts decreases by 10% to $711

Quantity of new posts decreases by 10% to 47,700

All other factors remain the same

NPV = $3,106,711

e. Sensitivity:

The NPV is most sensitive to the price and quantity of the new posts. A small change in these parameters can significantly impact the project's profitability.

f. Conclusion:

The project has a positive NPV and a high IRR, indicating that it is a financially viable investment. The payback period is also relatively short, which further increases its attractiveness. However, the sensitivity analysis shows that the NPV is highly dependent on the price and quantity of the new posts. Therefore, it is important for the company to closely monitor these factors and be prepared to adjust its strategy if necessary.