Integrative Problem and Virtual Organization
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Caledonia Products Integrative Problem
Why should Caledonia focus on project free cash flows as opposed to the accounting profits earned by the project when analyzing whether to undertake the project?
The reason why Caledonia should focus on free cash flows is because the amount that Caledonia will receive, they will be able to reinvest that amount into the business. Caledonia should examine the free cash flow so that they are able to see the real value amount or what the cost may be in the future. The marginal value from the project would be in the incremental cash flow. The earnings would be much less if they were looking at it through the accounting profits. It would be less because of the depreciation would be considered an expense causing a larger expense for Caledonia.
What is the projects initial outlay?
New Plant and Equipment: $7,900,000
Shipping and installation costs: $100,000
Fixed Cost for all 5 years: $1,000,000
Cost for Products all 5 years: $138,600,000
Total: $147,600,000
Tax 34%: $50,184,000
Discount Rate 15%: $7,527,600
What are the incremental cash flows for the project in years 1 through 5 and how do these cash flows differ from accounting profits or earnings?
Units Sold
Sales Price per unit
$300/unit year1-4 $260/unit year5
Variable Cost per unit
$180/unit
Annual fixed costs
Working capital
70,000
$21,000,000
$12,600,000
$200,000
$100,000
120,000
$36,000,000
$21,600,000
$200,000
$3,600,000
140,000
$42,000,000
$25,200,000
$200,000
$4,200,000
80,000
$24,000,000
$14,400,000
$200,000
$2,400,000
60,000
$16,600,000
$10,800,000
$200,000
$1,560,000
Depreciation for each year is $1,600,000
4. The cash flows associated with these projects are as follows:
-$100,000
-$100,000
$100,000
32,000
32,000
32,000
32,000
5. What is each projects net present value?
For project A, the projects net present value is $100,000 the initial investment overhead of the project is a negative expenditure because it is an expense to the company. Over the next five years the group expects to add the present annual value of $32,000, the return rate will be 11% utilizing the annuity table. The factor will be 3.696 at 11% for five years. To calculate the cash inflow, multiply the annual $32,000 by 3.696 at 11% to equal $118.272. Over a five year period the total cash inflow is $118,272 with a net value of $18,272 for project A. Net present value = $118,272 – $100,000 = $18,272. Projects net present value would be $18,269
What is each projects internal rate of return?
While Project IRR is 55.7362%
7.) Should the project be accepted? Why or Why not?
Yes the project should be accepted based on these criterias:
The project has a positive NPV.