**Capital Budgeting Case Fall, 2013**

FIN 3210

Due: 12/4/13

Ford Manufacturing (FM) is considering expanding into the Southeastern U.S., adding 40 centers to its fleet of 125. As the expansion is expected to significantly enhance both revenues and costs, senior management is concerned about the profitability of such a major expansion. As a result, you were recently hired to participate on a team under FM’s CFO that is responsible for evaluating the cash flows and profitability associated with this specific project (beginning in the summer of 2014).

Initially, your team concludes that such a full-scale expansion would require **an increase in capital expenditures** of **$16,400,000**. In addition, to accommodate increased cash and inventory needs, **net working capital requirements** are expected to rise by **$1,320,000** so the new centers will be operationally functional. The firm expects that 79% of the increase in net working capital will be returned at the project’s termination. The capital equipment is to be depreciated using a **5-year Modified Accelerated Cost Recovery System (MACRS) schedule**. Not knowing what the future holds, your team also concludes that this expansion will exist for **4 years** – thereby finishing in the summer of 2018.

Adjustments to the company’s operating cash flow’s are expected to begin in June of 2014 – when the centers are deemed fully operationally functional. Also, the capital equipment is expected to have a **market value of $2,205,000** **at the project’s termination**.

Last, your team makes the following assumptions regarding marginal increases in sales and costs for FM:

**870,000**more units will be sold in years 1-2, generating on average**$13.50**per unit, while**1,300,000**units will be**sold**in year 3-4 at an average sales price of**$14.50**per unit.- Total
**operating costs**(both fixed and variable) are anticipated to be**65% of sales**in years 1 & 2 and**55% of sales**in years 3 & 4. - FM’s
**marginal tax rate is 33%**(used in both deriving Operating Cash Flows as well as tax loss/gain in salvage value).

Last, you assume that FM will raise all of the capital to finance this project using a blend of debt and equity and intends to use the same capital structure to raise the funds for this expansion. As a result, you base your cost of capital assumptions on the following:

o The firm currently has 320 bonds outstanding with the following terms:

§ Remaining Maturity = 7 years, Coupon Rate = 5.48% (semiannual pay), Current Price = $1014**.**

o The firm currently has 42,000 common shares outstanding with the following price and market terms:

§ Stock price = $34; Beta = 1.32; Rf Rate = 2%; ERm = 7%

o The firm currently has 12,000 preferred shares outstanding with the following terms:

§ Share price = $88; Dividend Rate = 3.15%

*In order to evaluate this project, answer the following questions in deriving a cash flow analysis and recommendation.*

* *

*What is the initial cash outlay (CF0)?*

* *

*What are the operating cash flows in years 1 thru 5 - adjusted for taxes and depreciation?*

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*What are the terminal-year cash flows added to the operating cash flow in year 5?*

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*What is the Weighted Average Cost of Capital, assuming you use existing capital structure?*

* *

*Given your results for CF0 thru C04 and the cost of capital, would you recommend that the company take-on this project? Compute and explain the significance of the NPV & IRR to support your answer.*

* *

*Judging the existing weights in FM’s capital structure, comment on how the firm might lower its NPV and enhance its NPV and firm value by adjusting these weights. What could be the good/bad consequences of such adjustments?*

* *

Subject | Mathematics |

Due By (Pacific Time) | 12/05/2013 07:15 am |

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