Caledonia Products

Caledonia Products

Read the Mini Case from the end of Chapter 11 about Caledonia Products and thoroughly respond to Parts A to N at the end of the case as a concise management statement. Round any dollar amounts to the nearest dollar ($1,500,074) and any percentages to two decimals (9.56%).

Your Paper Must:

Answer all of the questions of the Mini Case in the form of a management statement. Do not simply list the questions and answers.

Explain the reasoning behind your answers and support your answers with examples from the text and other research.

Include both a Word document for your written answers and an Excel document for your calculated solutions.

For questions requiring calculations, use formulas in Excel to calculate your solution.

Guidelines for Writing the Final Paper

Word document must be four to six (4-6) double-spaced pages in length, exclusive of Appendix, References, Exhibits, etc.

Formatted according to APA style as outlined in the approved APA style guide (including title page, in text citations and reference list).

Must include an introductory paragraph with a succinct thesis statement.

Must address the topic of the paper with critical thought.

Must conclude with a restatement of the thesis and a conclusion paragraph.

Must use at least two scholarly sources, one of which may be the textbook.

Mini Case

It’s been 2 months since you took a position as an assistant financial analyst at Caledonia Products. Although your boss has been pleased with your work, he is still a bit hesitant about unleashing you without supervision. Your next assignment involves both the calculation of the cash flows associated with a new investment under consideration and the evaluation of several mutually exclusive projects. Given your lack of tenure at Caledonia, you have been asked not only to provide a recommendation but also to respond to a number of questions aimed at judging your understanding of the capital-budgeting process. The memorandum you received outlining your assignment follows:

To: The Assistant Financial Analyst

From: Mr. V. Morrison, CEO, Caledonia Products

Re: Cash Flow Analysis and Capital Rationing

We are considering the introduction of a new product. Currently we are in the 34 percent marginal tax bracket with a 15 percent required rate of return or cost of capital. This project is expected to last 5 years and then, because this is somewhat of a fad product, be terminated. The following information describes the new project:

Cost of new plant and equipment	$ 7,900,000
Shipping and installation costs	$ 100,000
Unit sales
	YEAR	UNITS SOLD
	1	70,000
	2	120,000
	3	140,000
	4	80,000
	5	60,000
Sales price per unit	$300/unit in years 1 through 4, $260/unit in year 5
Variable cost per unit	$180/unit
Annual fixed costs	$200,000 per year in years 1–5
Working-capital requirements	There will be an initial working-capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will be equal to 10 percent of the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5.
The depreciation method	Use the simplified straight-line method over 5 years. Assume that the plant and equipment will have no salvage value after 5 years.

• a.Should Caledonia focus on cash flows or accounting profits in making its capital-budgeting decisions? Should the company be interested in incremental cash flows, incremental profits, total free cash flows, or total profits?
• b.How does depreciation affect free cash flows?
• c.How do sunk costs affect the determination of cash flows?
• d.What is the project’s initial outlay?
• e.What are the differential cash flows over the project’s life?
• f.What is the terminal cash flow?
• g.Draw a cash flow diagram for this project.
• h.What is its net present value?
• i.What is its internal rate of return?
• j.Should the project be accepted? Why or why not?
• k.In capital budgeting, risk can be measured from three perspectives. What are those three measures of a project’s risk?
• l.According to the CAPM, which measurement of a project’s risk is relevant? What complications does reality introduce into the CAPM view of risk, and what does that mean for our view of the relevant measure of a project’s risk?
• m.Explain how simulation works. What is the value in using a simulation approach?
• n.What is sensitivity analysis and what is its purpose?

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