I need only to answer the following two questions on the below data:
• #3 question - What is the project’s initial outlay?
• #4 question - Sketch out a cash flow diagram for this project.
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
To: XXXXX XXXXX 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% tax bracket with a 15% discount
rate. This project is expected to last five years and then,
because this is somewhat of a fad project, it will be
terminated. The following information describes the new
Cost of new plant and equipment: $ 7,900,000
Shipping and installation costs: $ 100,000
Sales price per unit: $300/unit in years 1–4 and
$260/unit in year 5.
Variable cost per unit: $180/unit
Annual fixed costs: $200,000 per year
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% 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.Depreciation
method: Straight-line over 5 years
assuming the plant and equipment have no salvage value
after 5 years.