Central Florida Computer Company

Individual case analysis

Dinesh J Vatani
MSF 812: Capital Budgeting

Question 1 & 2: I recommend this project as it has a positive NPV:

Cash flows:

With expected sales of 390 units and terminal value of $420,000, Central Florida Computer Companys (CFCC) cash flows are shown above. The consulting cost of the plant should be considered as sunk cost. And since the company has a strict policy of not renting or leasing out its vacant production facilities, there is no opportunity cost associated with this plant. The book value of the plant is not incremental and hence the depreciation of plant shouldnt be considered.

Cost of Capital of the project is the companys WACC:

Here I use the required rate of return on equity 15.25% from CAPM as the cost of equity, not the estimated return on equity 16% estimated by the dividend and stock price. Then I get a WACC of 11.78% with 38% tax.

Question 3 If the economy is in recession and the company decides to sell the machinery, CFCC realize a loss for negative NPV. The cash flows are:

If in the recession, CFCC decide to continue the project, the cash flows will be as below and the NPV will be negative.

As shown, in continuing the project, CFCC realizes a bigger loss than by selling the machinery. Hence, in recession, if CFCC invested in the project and predicts that the recession will continue in the following 5 years, I will recommend the managers to sell the machinery in 19x1 at $850,000.

Question 4

As the results of Sensitivity analysis: 1. NPV is sensitive to changes in both two factors. 2. Only when the values of two factors are equal to or larger than their expected values, the project is successful. 3. NPV is more sensitive to changes in sales than to salvage value. The slope of sales change is larger than of salvage value.

Question 5 Please see excel file for simulation.