Solution
LIST OF CASE QUESTIONS
Case #5 – Fonderia Di Torino S.P.A
Case Study Questions.
- Evaluate the economic advantage of obtaining the Vulcan Mold-maker machine. Find the first investment? What are the long run advantages? Find the suitable offer price? Find whether the NPV permits the new investment?
First case expense:
New machine cost =1,010,000
(Machine 850,000 + Machine alteration 155,000 + Machine transportation 5,000)
Present after – taxation of the old machine.
= The offer price of old machine + (initial cost of old machine – accumulated devaluation of old machine) – The offer price of old machine * tax rate
= 130,000 + (415,807-130,682) -130,000 * 0.43
= 196,704
Net Expenditure for new machine.
= Expected new machine price + present post-tax market value of old machine.
= -1,010,000 + 196,704
= -813,296
The net first expenditure is € 813,296
Proper reduced charge
Rf = Return on investment of bond issued by E.U. governments = 5.3%
B = The company’s beta = 1.25
Calculating the Cost of Equity E(Ri)
=Rrf+βa∗(Rm−Rrf)
= 0.053 + 1.25 * 0.06
= 0.12
=12%
(Cost of Financing) = Interest rate * (1 – tax rate)
= Debt leverage * Rb + Equity leverage * Rs
= (33%) * (3.88%) + (67%) * (12.8%)
= 9.86%
The suitable offer rate estimation that we get from determining the return on investment or the capital asset pricing model (CAPM) and cost of debt, to find out the calculation of WACC (Weight Average Cost of Capital).
Net Present Value
On the assumption, we find NPV of cash flow difference between new machine and the old machine due to the fact that none of the sales information is provided.. We start by calculating the gross operating cost of old and new machine taking into consideration the workers expense, servicing expenses, and power expenses. Below is calculations of total operating cost of the new machine. (Assuming one 8 hours shift period
| New Machine (Vulcan Mold-Maker) | ||
| Employee cost |
1 Employee x € 11.4 x 2 shift x 8hrs x 210 days |
38,170 |
| Servicing cost | Annual | 59,500 |
| Power cost | Annual | 26,850 |
| Saving from the new machine | -5,200 | |
| Gross cost | € 119,320 |
Old machine gross operating cost is presented in the following table:
(Assuming its 8 hours shift time):
| Old Machine | ||
| Employee cost | 12 Worker x € 7.33 x 2 shift x 210 days x 8 hrs. | 295,546 |
| Servicing cost | 3 Worker x € 7.85 x 210 days x 12hrs | 39,564 |
| Power cost | Annual | 12,300 |
| Servicing cost | Annual | 4000 |
| Total Cost | € 351,410 |
Subsequently, we calculate the difference of devaluation expense between old and new machine. The devaluation expense of old machine of €47,250 was given on the paper. For new machine, the devaluation expense is calculated by dividing expected rate of new machine of $1,010,000 by 8 years. The following are result of the deviation on devaluation expense between old and new machine.
Devaluation Expense
=New Machine cost -Old Machine cost
= 126,250-47,520
=€ 78,730
Next, we calculate the cashflows difference as shown in the following table;
Cash Flow Difference (Old Machine – New Machine)
| Symbol | Old machine | Symbol | New Machine | Difference | ||
| Expense(E) | E1 | 351,410 | E2 | 119,320 | 232,090 | |
| Devaluation(D) | D1 | 47,520 | D2 | 126,250 | 78,730 | |
| (-E1)*(1-T)+(D1*T)
Cash Flow |
(-E2)*(1-T)+(D2*T) | (E1-E2)*(1-T)+(E2-E1)*T | ||||
| Tax | T | 43% | ||||
| Cash Flow Difference € 166,145.2 | ||||||
The cashflow table above shows the cashflow difference between the new and the old machine is € 166,145.2. It is also evident that the new machine is less profitable than the old machine. Assuming the machine will be operated for eight years, the depreciation will start at year 6. In year 7 and 8 devaluation is expected to be zero, thus making the difference between new and old machine to be €126,250 in those years.
The following is a workout of NPV without using 3%;
| Year | First
Investment |
Operating expense
Difference |
Devaluation
Difference |
Cash Flow
Difference |
WACC (without
inflation) |
PV of cash flow
difference |
NPV |
| 0 | (813,296.0) | (813,296.0 | 97,821.6 | ||||
| 1 | 232,090.0 | 78,730.0 | 166,145.2 | 9.86% | 151,233.5 | ||
| 2 | 232,090.0 | 78,730.0 | 166,145.2 | 9.86% | 137,660.2 | ||
| 3 | 232,090.0 | 78,730.0 | 166,145.2 | 9.86% | 125,305.1 | ||
| 4 | 232,090.0 | 78,730.0 | 166,145.2 | 9.86% | 114,058.9 | ||
| 5 | 232,090.0 | 78,730.0 | 166,145.2 | 9.86% | 103,822.1 | ||
| 6 | 232,090.0 | 78,730.0 | 166,145.2 | 9.86% | 94,504.0 | ||
| 7 | 232,090.0 | 126,250 | 186,578.8 | 9.86% | 96,601.7 | ||
| 8 | 232,090.0 | 126,250 | 186,578.8 | 9.86% | 87,931.7 |
The NPV of 97,821.6 suggests that the new machine will be good for the company and is therefore advisable for the new machine to replace the old machine. The company will enjoy quality product, reduced labor cost, lower scrap rates and improved labor efficiency leading to additional 5200 euros.
- What are the factor that may affect the recommendation? If the inflation rate is 3% or higher how will it influence the enchantment of Vulcan Mold Maker? Find how the NPV will be affected by any of the change in the fundamentals.
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