Case Study for Investment Analysis: Plant Expansion

Pat Gray, the Operation Manager at ABC Company, a producer of widgets, has analyzed sales projections for the next several years and has determined the only way production can keep up with sales is to build a new plant. Accordingly, Pat is in the process of preparing a Capital Investment Analysis for presentation to the Executive Team. The company competes in the food processing industry.

Here are the facts:

1. In the year just ended annual sales volume and plant capacity were:

  • Sales Volume: 500,000 Units
  • Plant Capacity: 600,000 Units

2. Due to actions included in the strategic plan, sales are projected to increase at 20% per year for each of the next 5 years.

3. Capital Spending on a new 650,000 units/year plant will cost:

  • $10.00 per unit for Buildings with a 5-year useful life
  • $5.00 per unit for Equipment with a 5-year useful life

4. If the project is approved in the next month the plant will be operating at the start of next year.

5. Working capital required for each new unit produced and sold equals:

  • $1.00 for receivables per unit sold
  • $1.50 for inventory per unit sold
  • ($.50) for payables per unit sold

6. Gross Margins are $10.00 per unit on the original and incremental production

7. Operating Costs are $1.50 per unit on the original and incremental production

8. The plant’s Terminal Value after 5 years is estimated to be $1,772,000

9. The company is currently capitalized as follows:

  • $20,000,000 Equity with an implied equity rate of return of 20%
  • $40,000,000 Debt with an average interest rate of 5.0 % with available additional debt at the same rate for this project.
  • The company uses its after-tax cost of debt to calculate its Weighted Average Cost of Capital

10. The company’s marginal tax rate is 25%

Your assignment is to prepare the Capital Investment Analysis for Pat assuming that after 5 years there is no production and no residual value for the new plant. Then write a recommendation on whether to undertake the project or not.

You can access the Capital Investment Request Form here.

To request the completed Case Study Capital Investment Request Form email Steve.Rosvold@CFO.University with “Please send me the completed Case Study CIRF”


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