Mini Case: Caledonia Products



Mini Case: Caledonia Products

Introduction

This paper provides an exploration into the cash flows of the new project currently under consideration in Caledonia Products. First, the paper presents the project's scenario: the company's IRR, Tax rate, unit sales from the project, and costing information. The questions' responses are based on the calculations of the expected cash flows of the project and project's cost and life considerations. The computations for the cash flows, IRR and NPV appear in the appendix.

Scenario

Caledonia is considering entering a project related to product development.

The project requires initial investment of $100000. The expected sales from this working capital investment is 10% of the dollar revenue. The project will incur plant and equipment costs of $ 7,900,000 and $ 100,000 cost for shipping and installation. The working capital is to be exhausted by the end of year 5, in which the project will be terminated. The existing rate of return for any project is 15%. Marginal tax applicable for the company's net income is 34%.

Unit Sales Table

Year

Units Sold

1

70000

2

120000

3

140000

4

80000

5

60000

Sales Price Per Unit

$ 3000=/ unit in years 1 through 4, $ 260 in year 5

Variable Cost Per Unit

$180/ unit

Fixed Costs/ Year

$200000 per annum

Solutions to Questions

Conventionally, the use of cash flows is an important measure for the profitability of a new project. These cash flows can further be reinvested for future income. However, the timing and cost of the cash flows determine the viability of a given project (Bierman 2009). Also, cash flows need to be adjusted for tax payments to determine the actual gain from the project. In all, a project is worth pursuing if it directs incremental cash flows for a company.

Even though we do not consider depreciation as a strict cash flow item, it still affects the overall cash flows from a projec (Kim 2006). By nature, depreciation is an expense item; the more it is incurred, the higher a company's expenses. The impact of depreciation is noted in the reduction of accounting profits of a firm. However, such an impact does not appear on the cash flow since the fixed assets on which it occurs are gradually devalued (Helfert 2001).

When we evaluate the capital feasibility of any project, we ignore the sunk costs. This is because sunk costs are not recoverable, even after the expiry or termination of the project. Hence, we only consider the post-tax incremental cash flows to ensure financial prudence.

e) and f)

The tasks for these questions relate with the projects' financial appraisal, taking the project's EBIT, depreciation, and taxes. Further, we compute the net working capital, change in net working capital, operating cash flows, and free cash flow for the project under review. The answers for these questions are presented in the tables appended at the end of this paper.

g.Cash flow diagram

$3,956,000$8,416,000$10,900,000$8,548,000$5,980,400

($8,100,000)

From the table appendix, we see the project's Net Present Value or NPV. The computation gives us the NPV $16,731,096 for the project. A positive NPV implies that a project is worth ...