Estimate incremental cash flows, Financial Management

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You just recently joined Manawatu Blinds and Curtains (MBC) group, a partnership firm based in Manawatu region providing windows, dressings, and installations to both commercial and residential clients in the Palmerston North area. The main products of the company are now wooden (real wood) blinds and curtains. As a financial analyst of the company, you are asked to evaluate a new product, TIMBERLIKETM, an alternative to real-

wood wooden blinds.  This is the special kind of new material which imitates the appearance of real woods but suffers less of the effects of moisture and color fades. It is also less expensive to customers, not to mention saving the forests.

The introduction of TIMBERLIKETM blinds will require a new setup of the

production line as the preparation/manufacturing processes are totally different from the now- running wooden blind production line, which is running at its full capacity. The new production facilities will be set up in an unused section of MBC main plant, which is located in a rather secluded area of suburban Palmerston North. A new machine with an estimated

cost of $375,000 will be purchased. It will cost another $30,000 to ship over the machine while $45,000 will be spent to have it installed. In addition, MBC's inventories (e.g. uncut TIMBERLIKE panels, TIMBERLIKE blinds in process, and finished TIMBERLIKE blinds) will increase by $15,000 since the very beginning (could be a few months in reality but just for simplification). The increase in such is projected to grow about 5% each year. The machine has a remaining economic life of 4 years of which the straight-line method of depreciation will be used. The salvage value is projected as 37,500 at the end of the fourth year.

The section of the plant where the TIMBERLIKE blinds would occur has been unused for ages. Consequently, it had suffered some rundown. In fact, last year during the routine overall facilities maintenance program, MBC spent $150,000 on that section of the plant. Based on figures from the marketing department, TIMBERLIKE blinds will generate yearly $600,000 in sales for the next four years. Related fixed and variable costs (together) are estimated as 75% of sales figures. This comes with the note that the introduction of TIMBERLIKE blinds will decrease the sales of MBC's real wooden blinds by $30,000 per year. The production costs of existing wooden blind are $15,000 per year (pre-tax). The appropriate cost of capital for MBC group is 10 %. The project will be funded by 70% debt and 30% equity. The average cost of debt (e.g. interest charges) for MBC group is 6.5%. Let's assume the corporate tax rate of 30%.

QUESTIONS

1.  Calculate the initial outlay of this project.

2.  Calculate the periodic total cash flows for year 1 to year 4 of this project.

3.  Suppose another merchant in the city expressed an interest in leasing the same cite (which will be used for LIKEWOOD blind production) for $5,000 a month, how would you incorporate this information into your analysis?

4.  Express your views of additional points that should be considered beyond the available information given in this case (e.g. anything missing from a good and thorough analysis?).


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