LIST OF CASE QUESTIONS

Case #5 – Fonderia Di Torino S.P.A

Questions for Case Preparation.

The following questions will help you in the preparation and analysis of this case. Use these questions as a guide in your study of the case. However, do not limit yourselves to these questions only, but rather allow yourselves to expand your thinking and analysis of this case.

**Please assess the economic benefits of acquiring the Vulcan Mold-Maker machine. What is the initial outlay? What are the benefits over time? What is an appropriate discount rate? Does the net present value (NPV) warrant the investment in the machine?**

First case expense:

New machine cost =**1,010,000**

(Machine 850,000 + Machine alteration 155,000 + Machine transportation 5,000)

Present after – tax market cost of old machine.

= The offer cost of old machine + (initial cost of old machine – accumulated devaluation of old machine) – The discount price of old machine * tax rate

= 130,000 + (415,807-130,682) -130,000 * 0.43

**= 196,704**

Net Expenditure for new machine.

= Expected cost of new machine + 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

Rs (Cost of Capital /CAPM = Rf + B(Rm – Rf)

= 5.3% + 1.25 * 6%

= 12.8%

Rb (Cost of Debt) = 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 calculate NPV of cash flow disparity between old machine and new machine due to the fact that there was no obtainable information about the sales. We start by calculating the total operating expense of new machine and old machine considering the labor expense, servicing expenses, and electric expenses. Total operating expense of new machine can be found as below (Assuming one 8 hours shift period

New Machine (Vulcan Mold-Maker) | |

Labor Expense 1 Employee x € 11.36 x 8 hr. x 2 shift x 210 day | 38,170 |

Servicing Expense Contract / year | 59,500 |

Electrical Power / Year | 26,850 |

Save of automatic machine | (5,200) |

Total Expense | € 119,320 |

Total operating expense of old machine can be following table

(Assuming its 8 hours shift time):

Old Machine | |

Employee cost 12 Worker x € 7.33 x 8 hr. x 2 shift x 210 days | 295,546 |

Servicing expense 3 Worker x € 7.85 x 12 x 210 days | 39,564 |

Servicing Supplies / Year | 4,000 |

Electrical Power / Year | 12,300 |

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 | ||

Sales (S) | S | N/A | S2 | N/A | ||

Cost (C | C1 | 351,410 | C2 | 119,320 | 232,090 | |

Depreciation | D1 | 47,520 | D2 | 126,250 | 78,730 | |

(S-C1)*(1-T)+(D1*T) Cash Flow | (S-C2)*(1-T)+(D2*T) | (C1-C2)*(1-T)+(D2-D1)*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%;….

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