question archive James Weber Corp

James Weber Corp

Subject:FinancePrice:3.87 Bought7

James Weber Corp. (JWC), a prominent Canadian manufacturer with many production facilities across Canada, has been considering opening another manufacturing plant. A recently completed feasibility study costing $2,000,000 concluded that, in order for JWC to maintain its market share, expansion should be seriously considered. JWC is considering Winnipeg as the site of the expansion project citing the availability of industrial parks as a major reason. If the expansion project proceeds, JWC believes it can purchase land, building, and the required machinery for $120,000,000. The cost of the building is expected to be $75,000,000, while that of the machinery will be $5,000,000. The building will belong to a CCA class that has a rate of 5%; the machinery will belong to a CCA class with a rate of 25%. (JWC has many assets in these classes.) The land is not considered amortizable and, as such, does not have a CCA class. Because of changing market conditions, JWC believes that the competitive advantage associated with the expansion will last only 5 years and after 5 years is prepared to close the new facility and pursue other opportunities. At the end of the five years JWC intends to sell the land for an amount equal to its purchase price, to sell the building for $60,000,000, and write-off the equipment for no value. Incremental pre-tax revenues associated with the expansion project are estimated to be $35,000,000 for the first year of the project and are expected to rise at 5% per year for the remainder of the project. Incremental pre-tax expenses associated with the expansion project are estimated to be $10,000,000 for the first year of the project but are expected to decline at 4% per year for the remainder of the project. (Assume the cash flows associated with these incremental revenues and expenses will occur at the end of each year.) JWC´s working capital will most certainly rise if the project proceeds. An estimate proposes that the project-related additional working capital requirements by year will need to be the following: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 $4,000,000 $5,000,000 $6,000,000 $3,000,000 $1,000,000 $0 An unfortunate choice associated with Winnipeg is the relatively high cost of labour. JWC believes that this will result in increased labour costs at its other manufacturing plants across Canada. JWC intends to phase in these increased costs over a 2-year period, and estimates that it will have to add $2,000,000 in payroll costs in the first year of the project and add an additional $2,000,000 (i.e., a total of $4,000,000 above pre-project levels) in the second year of the project. In further expects that the increased payroll costs at its other plants will then continue indefinitely. (Assume the cash flows associated with these additional payroll costs will occur at the end of each year.) JWC´s income tax rate is 40%, and it has decided that an appropriate discount rate for this type of project is 14%. Do an NPV analysis to determine if JWC should proceed with its expansion plans. (Assume that all cash flows and the costs of capital (the discount rate) are given in nominal terms.)

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Answer:

Rate

5%

       

Building

75000000

       

Depreciation

1875000

3656250

3473438

3299766

3134777

Book Value

73125000

69468750

65995313

62695547

59560770

           

Rate

25%

       

Machinery

5000000

       

Depreciation

625000

218750

207812.5

197421.9

187550.8

Book Value

4375000

4156250

3948438

3751016

3563465

           

Total Dep. Exp

2500000

3875000

3681250

3497188

3322328

CCA calculation: 1st year depreciation = Value of asset * depreciation rate * 50%

2nd year Depreciation = Book Value of Asset * Depreciation Asset

Book Value of 1st year = Value of asset – Depreciation in first year.

The remaining year depreciation will follow the 2nd year depreciation calculation format.

Working Capital Required

4000000

5000000

6000000

3000000

1000000

0

Cash flow due to Working Capital

-4000000

-1000000

-1000000

3000000

2000000

1000000

Cash flow due to WC = Previous year WC - Current Year WC

Timeline 0 1 2 3 4 5
Initial Investment -120000000          
Revenue (5% rise every year)   35000000 36750000 38587500 40516875 42542718.8
Expense (4% decline every year)   -10000000 -9600000 -9216000 -8847360 -8493465.6
EBITDA   25000000 27150000 29371500 31669515 34049253.2
Depreciation Exp.   -2500000 -3875000 -3681250 -3497187.5 -3322328.1
EBT   22500000 23275000 25690250 28172327.5 30726925
Tax @ 40%   -9000000 -9310000 -10276100 -11268931 -12290770
EAT   13500000 13965000 15414150 16903396.5 18436155
Add: Dep. Exp   2500000 3875000 3681250 3497187.5 3322328.13
Payroll Cost   -2000000 -2000000      
Cash flow due to Working Capital -4000000 -1000000 -1000000 3000000 2000000 1000000
Salvage value building           60000000
Salvage value land           40000000
Salvage value equipment           0
Net Cash flow -124000000 13000000 14840000 22095400 22400584 122758483
             
Discounted Rate 14%          
PV $11,47,56,025.95 =NPV(14%,D18:H18)        
NPV -$92,43,974.05 (PV-Net Cash flow at timeline 0)