Professional Documents
Culture Documents
Argile Textiles Is Evaluating A New Product A Silk Wool Blended
Argile Textiles Is Evaluating A New Product A Silk Wool Blended
Argile Textiles Is Evaluating A New Product A Silk Wool Blended
wool blended
Argile Textiles is evaluating a new product, a silk/wool blended fabric. Assume that you were
recently hired as assistant to the director of capital budgeting, and you must evaluate the
proposed project. The fabric would be produced in an unused building located adjacent to
Argile’s Southern Pines, North Carolina, plant; Argile owns the building, which is fully
depreciated. The required equipment would cost $200,000, plus an additional $40,000 for
shipping and installation. With the new project, inventories would rise by $25,000, and accounts
payable would increase by $5,000. All of these costs would be incurred at t = 0. By a special
ruling, the machinery could be depreciated under the MACRS system as 3-year property.
The project is expected to operate for four years, and then be terminated. The cash inflows are
assumed to begin one year after the project is undertaken, or at t = 1, and to continue to t = 4.
At the end of the project’s life (t = 4), the equipment is expected to have a salvage value of
$25,000.
Unit sales are expected to total 100,000 five-yard rolls per year, and the expected sales price is
$2 per roll. Cash operating costs for the project (total operating costs excluding depreciation)
are expected to amount to 60 percent of dollar sales. Argile’s marginal tax rate is 40 percent,
and its required rate of return is 10 percent. Tentatively, the silk/wool blend fabric project is
assumed to be of equal risk to Argile’s other assets. You have been asked to evaluate this
project and to make an accept/reject recommendation. To guide you in your analysis, your boss
has asked you to answer the following set of questions.
a. What is capital budgeting? Are there any similarities between a firm’s capital budgeting
decisions and an individual’s investment decisions?
b. What is the difference between independent and mutually exclusive projects? Between
projects with conventional cash flows and projects with unconventional cash flows? Between
replacement analysis and expansion analysis?
c. Draw a cash flow timeline that shows when the net cash inflows and outflows will occur with
Argile’s proposed project, and explain how the timeline can be used to help structure the
analysis.
d. Argile has a standard form that is used in the capital budgeting process; it is shown in Table
IP13-1. Part of the table has been completed, but you must compute the missing values.
Complete the table in the following steps:
(1) Complete the unit sales, sales price, total revenues, and operating costs (excluding
depreciation) lines.
(2) Complete the depreciation line.
(3) Complete the table down to net income and then down to net operating cash flows.
(4) Fill in the blanks under Year 0 and Year 4 for the initial investment outlay and the terminal
cash flows, respectively. Next, complete the cash flow timeline (net cash flow). Discuss the role
of working capital. What would have happened if the machinery were sold for less than its book
value?
e. (1) Argile uses debt in its capital structure, so some of the money used to finance the project
ANSWER
https://solvedquest.com/argile-textiles-is-evaluating-a-new-product-a-silk-wool-blended/