Expert answer:Mini Case – Caledonia Products
Answer & Explanation:Focus
of the Final ProjectRead the Mini Case
from the end of Chapter 11 about Caledonia Products and thoroughly respond to
Parts a to n at the end of the case. Your paper should answer all of the
questions of the Mini Case (without repeating the questions), as a concise
management statement in four to six pages. Explain the reasoning behind your
answers and support your answers with examples from the text and other
research. Where appropriate, properly cite the text or any other source.
For questions requiring calculations, use formulas in Excel to calculate the
ratios and format the cells to insert a comma if there are more than three
numbers. Submit your work as a separate Excel document, in addition to your
analysis. Round dollar amounts to the nearest whole number and percentages to
two decimal places as a percentage. Clearly label your analysis and the sum of
your conclusions for all parts of the case.
Writing the Final ProjectThe Final Project:
1.
Must be four to six
double-spaced pages in length, and formatted according to APA style as outlined
in the Ashford Writing Center.
2.
Must include a title
page with the following:
a. Title of paper, b. Student’s name, c. Course name and number,
d. Instructor’s name, e. Date submitted
3.
Must begin with an introductory
paragraph that has a succinct thesis statement.
4.
Must address the topic
of the paper with critical thought.
5.
Must end with a
conclusion that reaffirms your thesis.
6.
Must use at least two
scholarly sources, one of which may be the textbook.
7.
Must document all
sources in APA style, as outlined in the Ashford Writing Center.
8.
Must include a
separate reference page, formatted according to APA style as outlined in the
Ashford Writing Center.
Mini Case
It’s been 2 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 percent marginal tax
bracket with a 15 percent required rate of return or cost of capital. This
project is expected to last 5 years and then, because this is somewhat of a fad
product, 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 through 4, $260/unit in
year 5
Variable cost per unit
$180/unit
Annual fixed costs
$200,000 per year in years 1–5
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 percent 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.
The depreciation method
Use the simplified straight-line method over
5 years. Assume that the plant and equipment will have no salvage value after
5 years.
a. Should Caledonia focus on cash flows or
accounting profits in making its capital-budgeting decisions? Should the
company be interested in incremental cash flows, incremental profits, total
free cash flows, or total profits?
·
b. How does
depreciation affect free cash flows?
·
c. How do sunk costs
affect the determination of cash flows?
·
d. What is the
project’s initial outlay?
·
e. What are the
differential cash flows over the project’s life?
·
f. What is the
terminal cash flow?
·
g. Draw a cash flow
diagram for this project.
·
h. What is its net
present value?
·
i. What is its
internal rate of return?
·
j. Should the project
be accepted? Why or why not?
·
k. In capital
budgeting, risk can be measured from three perspectives. What are those three
measures of a project’s risk?
·
l. According to the
CAPM, which measurement of a project’s risk is relevant? What complications
does reality introduce into the CAPM view of risk, and what does that mean for
our view of the relevant measure of a project’s risk?
·
m. Explain how
simulation works. What is the value in using a simulation approach?
·
n. What is sensitivity
analysis and what is its purpose?
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