Question

Case Study Description A $6M investment is considered by an electric bike manufacturing company to add a new production line for its new product, electric skateboards. The company has commissioned an exploratory study of where to place the new production line and which type of equipment to use. There are three types of machines to choose from for the company to install on the new assembly line. The machines have zero salvage value at the end of 10-year planning horizon. The company must select at least two alternatives from (i) Loan, (ii) Common Stocks, (iii) Preferred Stocks, and (iv) Retained Earnings to obtain the required amount of capital for the investment. Each of these capital sources could provide $3M to support the project. The company is anticipating rapid product penetration and aggressive growth after addition of the new production line. The major question for this case study is to find out if the project is economically justified.

Part I: Cash Flow Construction, Please follow this step to create the cash flow of the project and obtain its economic worth.

Choose the Capital Sources and Calculate WACC.

Options Capital Sources Description option1: Loan Interest Rate = 8 %, Compounded Semi Annually Payback Method: Plan 3 and option 2: Retained Earning -

Part 2: Calculate MARR: Set MARR equal to rounded WACC (Round up WACC) + 3% for your further analysis.

Part 3: Choose the type of Machine and Calculate Before Tax Cash Flow (BTCF)

No. of Machines	20
First Cost	$250,000
Operating Cost/Hr	120
Revenue/Hr.	190
Hr/year	1700
Useful Life	10
Years Depreciation (MACRS)	7

Step 4: Economic worth calculation Find (i) PW, (ii) DPBP, (iii) IRR based on BTCF.

Step 5:Tax rate: 28%

Step 6: construct the After-Tax Cash Flow (ATCF) and then calculate the corresponding (i) PW, (ii) AW, and (iii) IRR for the ATCF.

Step 7: Inflation rate 4% and calculate ATCF Choose the appropriate value for the Inflation rate from the following table and calculate (i) PW, (ii) ERR and (iii) IRR based on ATCF.

Answer 1

Year Year Year Year Year Year Year Year Year Year Year 4 6 5 7 1 3 8 9 10 Common Stock 3.000,000 3.000.000 Loan Part I: WACC Calculation Cost of Loan funds Loan funds 8.00% Pre tax Cost 28.00% Tax Rate 5.76% Post tax cost of funds 12% Cost of retained funds assumed to be 12 % as we do not have details of ROl of the company till now Cost of Retained Funds (assumed) Equity portion of investment (here investment is equal from both sources) Cost of debt funds investment +cost of equity funds WACC debt portion 8.88 % Part 2 MARR WACC+3 % 11.88% Part 3 Initial Cost 250.000 No of Machines 20 Total Initial cost 5.000.000 Hours per year 1,700 1.700 1,700 1.700 1,700 1,700 1,700 1,700 1,700 1.700 Revenue/hour 190 190 190 190 190 190 190 190 190 190 Cost/hour 120 120 120 20 120 120 20 20 120