Integrative Problem and Virtual Organization

Caledonia Products Integrative Problem

1. 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.

2. What is the project's 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

3. 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?

Year Units Sold Sales Price per unit

$300/unit year1-4 $260/unit year5

Variable Cost per unit

$180/unit Annual fixed costs

Working capital

1 70,000 $21,000,000 $12,600,000 $200,000 $100,000

2 120,000 $36,000,000 $21,600,000 $200,000 $3,600,000

3 140,000 $42,000,000 $25,200,000 $200,000 $4,200,000

4 80,000 $24,000,000 $14,400,000 $200,000 $2,400,000

5 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:

YEAR

0 -$100,000 -$100,000

1 $100,000

2 32,000 0

3 32,000 0

4 32,000 0

5 32,000 0

5. What is each project's 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

6. What is each project's 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 criteria's:

1. The project has a positive NPV.

2. The