Describe the concept of incremental cash flows

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Eureka Bottling Company was established in 1992 by Josie Smith. The company was extremely successful at the beginning of the 21st century, but sales have waned since then. In an attempt to rejuvinate EBC's sales, Ms. smith has developed a new process of purifying and bottling water. She believes that this will increase Euerka's sales.EBC hired a marketing consultant firm to analyze expected sales. The cost of the consultant was $53,000. for the first year of manufacturing, the consultant forecasted sales of $22,000 cases at $76 per case. After the first year, the consultant forecasted a 2.2% increase in cases per year. The estimated cost of manufacturing per case is $51 in year one. Fixed costs including additional staffing will increase by $82,000 per year. EBC expects a yearly loss of $360,000 on current cash flows.An economist forecasted inflation rates for EBC prices and costs. Prices are expected to increase at a rate of 1.7% per year while manufacturing coasts are expected to grow at a rate of 1.9% per year for the foreseeable future.EBC will need to purchase manufacturing equipment at a cost of $548,000 and shipping and installation will cost $48,000. The equipment falls under the MACRS 5- year classification. For the new purifying and bottling process, raw materials and accounts payable need to increase to $63,000.In order to raise capital to finance the project, EBC plans to borrow 40% of the needed capital from a bank. this long- term bank loan will have a before-tax cost of 9.2%. The remaining capital will come from the internal equity at a cost of 18%. EBC marginal tax rate is 40%.Ms. Smith would like you to evaluate the feasibility of undertaking the purifying and bottling project. She will pay you very well, but she requires a full analysis and answers to many questions about this project and your analysis. You need to provide detailed cash flow information for the up-front costs and the cash flows for each year, one through seven. After year seven, you should assume that the project's net operating cash flows will grow at a rate of -3.5% per year due to competition and maintenance.

The following represent issues that you should address in your report to Ms. Smith and EBC:

1. Calculate the weighted average cost of capital for this project.

2. Describe the concept of incremental cash flows and explain why it is important in capital budgeting analysis.

3. Calculate the proposed project's initial investment and describe the components. Be sure to discuss the $73,000 paid to the marketing consulting firm and indicate the appropriate treatment of this cost.

4. Calculate the proposed project's net cash flows from operations and the terminal value.

5. Describe why MACRS depreciation is relevant from a finance perspective. Your description should include why MACRS is better than straight-line depreciation.

6. Calculate the project's NPV, IRR, MIRR, PI, and PB. Based on this analysis, what will you recommend to Ms. Smith and EBC? Why?

7. Rather than doing the water purifying and bottling project, EBC could lease the building used for the project at $70,000 per year indefinitely. The lease agreement is standard in that payments are made at the beginning of each year. How will this information affect the analysis of the project? Calculate the Projects NPV and IRR.

8. Overall, give your recommendation to Ms. Smith and EBC.

Reference no: EM131027195

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