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Please answer questions 5 and 6 i n the based o n the cape chemical scenerio i n the images. I a m really stuck.SCL THE SITUATION ‘The unexpected withdrawal of one of Cape Chemical’s competitors from the region has provided the opportunity to increase its blended packaged goods sales. That's the good news. The bad news is Cape Chemical’s blending equipment is operating at capacity, thus to take advantage of this opportunity, additional equipment must be obtained, requiring a major capital investment. It is estimated that Cape Chemical must increase its annual blending capacity by 800,000 gallons to meet expected demand for the next three years Annual capacity must increase by 1,400,000 gallons to meet projected demand beyond the next three years. Stewart is considering two alternatives proposed by the company’s engineer. The first is the acquisition and installation of used equipment that will provide the capacity to blend an additional 800,000 gallons annually. The used equipment will cost $105,000 to acquire and $15,000 to install. ‘The equipment is projected to have an estimated life of three years. The second option is the acquisition and installation of new equipment with the capacity to blend 1,600,000 gallons annually. The new equipment would have a substantially higher cost of $360,000 to acquire and $60,000 to install, but have a higher capacity and an economic life of seven years. The new equipment is also more efficient thus the cost of blending is less than the blending cost of the used equipment. Stewart asked Clarkson to lead the evaluation process. Stewart thinks the used equipment could be obtained without a new bank loan. The acquisition of the new equipment would require new bank borrowing. The evaluation of each alternative will require an estimate of the financial benefits associated with each. The marketing and sales staff estimated incremental sales of blended package material will be 600,000 gallons the first year and increase by 15% each year thereafter. During the last year, the average selling price for blended material has been near $4.05 per gallon and material cost (not including a cost for blending the material) has been approximately $3.53. The ‘marketing staff anticipates no significant change in either future selling prices or product costs; however they do estimate variable selling and administrative expenses associated with the increased blended material sales to be $.20 per gallon. 136 Weighted Average Cost of Capital (WACC) Using input from an investment banking firm, Clarkson estimates the company’s cost of equity to be 18%. Their bank has indicated a long-term bank loan can be arranged to finance the new equipment at an annual interest rate of 12% (before tax cost of debt). The bank would require the loan to be secured with the new equipment. The loan agreement would also include a number of restrictive covenants, including a limitation of dividends while the loans are outstanding. While long-term debt is not included in the firm's current capital structure, Clarkson believes a 30% debt, 70% equity capital mix would be appropriate for Cape Chemical. Last year, the company's federal-plus-state income tax rate was 30%. Clarkson does not expect the income tax rate to change in the foreseeable future. Used Equipment The used equipment will cost $105,000 with another $15,000 required to install the equipment. ‘The equipment is projected to have an economic life of three years with a salvage value of $9,000. The equipment will provide the capacity to blend an additional 800,000 gallons annually. The variable blending cost is estimated to be $.20 per gallon. The equipment will be depreciated under the Modified Accelerate Cost Recovery System (MACRS) 3-year class. Under the current tax law, the depreciation allowances are 0.33,0.45, 0.15, and 0.07 in years 1 through 4, respectively. The increased sales volume will require an additional investment in working capital of 2% of sales (to be on hand at the beginning of the year). 4. Evaluate the strengths and weaknesses of the Cash Payback Period, Discounted Cash Payback Period, NPV, IRR and MIRR capital expenditure budgeting methods. Prepare a recommendation for Stewart regarding the capital budgeting method or methods to use in evaluating the expansion alternatives. Support your answer. 5. Calculate the Cash Payback Period, Discounted Cash Payback Period, NPV, IRR and MIRR for each alternative. For the calculations, assume a WACC of 15%. Based on the results of these ‘methods, should either option be selected? Why? Solution requires preparation ofa spreadsheet. 6. Stewart is concerned that the projected annual sales growth rate of 15% for incremental blended ‘material may be optimistic. Recalculate the Cash Payback Period, Discounted Cash Payback Period, NPV, IRR and MIRR for each alternative assuming the annual sales growth rates of 10% and 5%. Assume a WACC of 15%. Does the change in growth rate alter the recommendation ‘made in question 5? Solution requires preparation of spreadsheets. Explain. 7. The projected cash flow benefits of both projects did not include the effects of inflation. Future cash flows were determined using a constant selling price and operating costs (real cash flows). The cash flows were then discounted using a WACC that included the impact of inflation (nominal WACC). Discuss the problem with using real cash flows and a nominal WACC when calculating a project’s Discounted Payback Period, NPV, IRR and MIRR. 8. ‘What other issues should Stewart and Clarkson considered before a final decision regarding the expansion alternatives is made?

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Please answer questions 5 and 6 i n the based o n the cape chemical scenerio i n the images. I a m really stuck.Uploaded ImageUploaded ImageUploaded ImageSCL THE SITUATION ‘The unexpected withdrawal of one of Cape Chemical’s competitors from the region has provided the opportunity to increase its blended packaged goods sales. That's the good news. The bad news is Cape Chemical’s blending equipment is operating at capacity, thus to take advantage of this opportunity, additional equipment must be obtained, requiring a major capital investment. It is estimated that Cape Chemical must increase its annual blending capacity by 800,000 gallons to meet expected demand for the next three years Annual capacity must increase by 1,400,000 gallons to meet projected demand beyond the next three years. Stewart is considering two alternatives proposed by the company’s engineer. The first is the acquisition and installation of used equipment that will provide the capacity to blend an additional 800,000 gallons annually. The used equipment will cost $105,000 to acquire and $15,000 to install. ‘The equipment is projected to have an estimated life of three years. The second option is the acquisition and installation of new equipment with the capacity to blend 1,600,000 gallons annually. The new equipment would have a substantially higher cost of $360,000 to acquire and $60,000 to install, but have a higher capacity and an economic life of seven years. The new equipment is also more efficient thus the cost of blending is less than the blending cost of the used equipment. Stewart asked Clarkson to lead the evaluation process. Stewart thinks the used equipment could be obtained without a new bank loan. The acquisition of the new equipment would require new bank borrowing. The evaluation of each alternative will require an estimate of the financial benefits associated with each. The marketing and sales staff estimated incremental sales of blended package material will be 600,000 gallons the first year and increase by 15% each year thereafter. During the last year, the average selling price for blended material has been near $4.05 per gallon and material cost (not including a cost for blending the material) has been approximately $3.53. The ‘marketing staff anticipates no significant change in either future selling prices or product costs; however they do estimate variable selling and administrative expenses associated with the increased blended material sales to be $.20 per gallon. 136 Weighted Average Cost of Capital (WACC) Using input from an investment banking firm, Clarkson estimates the company’s cost of equity to be 18%. Their bank has indicated a long-term bank loan can be arranged to finance the new equipment at an annual interest rate of 12% (before tax cost of debt). The bank would require the loan to be secured with the new equipment. The loan agreement would also include a number of restrictive covenants, including a limitation of dividends while the loans are outstanding. While long-term debt is not included in the firm's current capital structure, Clarkson believes a 30% debt, 70% equity capital mix would be appropriate for Cape Chemical. Last year, the company's federal-plus-state income tax rate was 30%. Clarkson does not expect the income tax rate to change in the foreseeable future. Used Equipment The used equipment will cost $105,000 with another $15,000 required to install the equipment. ‘The equipment is projected to have an economic life of three years with a salvage value of $9,000. The equipment will provide the capacity to blend an additional 800,000 gallons annually. The variable blending cost is estimated to be $.20 per gallon. The equipment will be depreciated under the Modified Accelerate Cost Recovery System (MACRS) 3-year class. Under the current tax law, the depreciation allowances are 0.33,0.45, 0.15, and 0.07 in years 1 through 4, respectively. The increased sales volume will require an additional investment in working capital of 2% of sales (to be on hand at the beginning of the year). 4. Evaluate the strengths and weaknesses of the Cash Payback Period, Discounted Cash Payback Period, NPV, IRR and MIRR capital expenditure budgeting methods. Prepare a recommendation for Stewart regarding the capital budgeting method or methods to use in evaluating the expansion alternatives. Support your answer. 5. Calculate the Cash Payback Period, Discounted Cash Payback Period, NPV, IRR and MIRR for each alternative. For the calculations, assume a WACC of 15%. Based on the results of these ‘methods, should either option be selected? Why? Solution requires preparation ofa spreadsheet. 6. Stewart is concerned that the projected annual sales growth rate of 15% for incremental blended ‘material may be optimistic. Recalculate the Cash Payback Period, Discounted Cash Payback Period, NPV, IRR and MIRR for each alternative assuming the annual sales growth rates of 10% and 5%. Assume a WACC of 15%. Does the change in growth rate alter the recommendation ‘made in question 5? Solution requires preparation of spreadsheets. Explain. 7. The projected cash flow benefits of both projects did not include the effects of inflation. Future cash flows were determined using a constant selling price and operating costs (real cash flows). The cash flows were then discounted using a WACC that included the impact of inflation (nominal WACC). Discuss the problem with using real cash flows and a nominal WACC when calculating a project’s Discounted Payback Period, NPV, IRR and MIRR. 8. ‘What other issues should Stewart and Clarkson considered before a final decision regarding the expansion alternatives is made?

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Asked by: REDDY BHARGAVA SURYA TEJA
Created at: 2025-11-22 16:56:05

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Certainly! Here’s a step-by-step guide on how to approach **questions 5 and 6** for the Cape Chemical scenario. I’ll outline what you need to do and give you the formulas, structure, and reasoning you’ll use. You’ll need to build the actual spreadsheet to get exact numbers, but this will get you fully started and help you the process. --- # **Question5** ##Restated Question** Calculate the **Cash Payback Period**, **Discounted Cash Payback Period**, **NPV**, **IRR**, and **MIRR** for each alternative. Assume a **WACC of 15%**. Should either option be selected? Why? ## **Step-by-Step Process** ### **1. Gather Key Data** #### **Used Equipment** - **Cost:** $105,000 + $15,000 = $120,000 (initial outlay) - **Salvage Value:** $9,000 (end of 3 years) - **Capacity:** 800,000 gallons/year - **Life:** 3 years - **Blending Cost:** $.20/gallon - **Depreciation:** MACRS 3-year (.33, .45, .15, .07) - **Additional Working Capital:** 2% of sales (on hand at start of each year) - **Variable Selling/Administrative:** $.20/gallon #### **New Equipment** - **Cost:** $360,000 + $60,000 = $420,000 - **Life:** 7 years - **Capacity:** 1,600,000 gallons/year - (Other details to be filled similarly, if provided.) #### **General** - **Selling Price:** $4.05/gallon - **Material Cost:** $3.53/gallon - **WACC:** 15% - **Tax Rate:** 30% - **Annual Incremental Sales:** 600,000 gallons (Year 1), grows by 15% per year ### **2. Calculate Incremental Cash Flows (Year by Year)** For each year (for each alternative): - **Revenue:** Units Sold × Price per Gallon - **Costs:** - Material: Units × $3.53 - Blending: Units × $.20 (used equipment) - Selling/Admin: Units × $.20 - **Depreciation:** Based on MACRS schedule - **EBIT:** Revenue - Total Costs - Depreciation - **Taxes:** EBIT × 30% - **Net Income:** EBIT - Taxes - **Add Back Depreciation** - **Subtract Working Capital Investment (2% × Sales)** - **Add Salvage Value (in final year only)** **Operating Cash Flow = Net Income + Depreciation - ΔNet Working Capital** ### **3. Compute Metrics** - **Cash Payback Period:** Years needed to recover initial investment from cumulative cash flows. - **Discounted Payback Period:** Years needed to recover investment from discounted cash flows (using 15% WACC). - **NPV:** Sum of discounted cash flows (including salvage value and NWC recovery). - **IRR:** Rate that sets NPV to zero. - **MIRR:** Modified IRR using WACC. --- ## **Example Table Structure for Spreadsheet** | Year | Units Sold | Revenue | Costs | Depreciation | EBIT | Taxes | NI | Operating CF | Cumulative CF | Discounted CF | Cumulative Discounted CF | |------|------------|---------|-------|--------------|------|-------|----|--------------|---------------|---------------|-------------------------| | | | | | | | | | -Initial Outlay | | | | | 1 | | | | | | | | | | | | | ... | | | | | | | | | | | | --- ### **4. Decision** - If **NPV > **, the investment is financially attractive. - Compare **IRR** and **WACC** (should be higher than WACC). - Consider Payback for liquidity risk. --- # **Question 6** ## **Restated Question** Recalculate **all metrics** (Payback, Discounted Payback, NPV, IRR, MIRR) for **growth rates of 10% and 5%** (not 15%). Does this change your recommendation from Q5? ## **Approach** - **Repeat the cash flow projections** as above, but now sales volume grows by 10% and 5% per year after year 1, not 15%. - Use the same WACC (15%). - Recalculate all metrics for both alternatives. --- ### **Discussion** - **If the NPV becomes negative** or IRR drops below WACC at lower growth rates, the project is no longer attractive. - Compare the sensitivity: Which alternative is more robust to slower growth? - If only one alternative remains viable at lower growth, recommend that one—or neither, if both are unattractive. --- ## **Summary Table for Results** | Alternative | Growth Rate | Payback | Discounted Payback | NPV | IRR | MIRR | Accept/Reject | |----------------|-------------|---------|--------------------|----------|---------|---------|---------------| | Used Equip | 15% | | | | | | | | Used Equip | 10% | | | | | | | | Used Equip | 5% | | | | | | | | New Equip | 15% | | | | | | | | New Equip | 10% | | | | | | | | New Equip | 5% | | | | | | | --- # **Summary of What To Do** 1. **Set up your spreadsheet** with the structure above. 2. **Input all cost and revenue data** for each alternative. 3. **Project cash flows** year-by-year for each growth scenario (15%, 10%, 5%). 4. **Calculate payback, discounted payback, NPV, IRR, and MIRR** for each case. 5. **Compare results and discuss** which, if any, alternative should be selected under each scenario. --- ## **Conclusion** - **If NPV remains positive at lower growth rates**, that alternative is less risky and more robust. - **If both alternatives become unattractive at lower rates**, caution is warranted. --- If you need help **setting up the formulas or a sample spreadsheet**, let me know, and I can provide a mockup in Excel format or stepwise calculations for each column!

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