Bender Guitar Corporation: Custom Electric Guitar Manufactur

Bender Guitar Corporation A Manufacturer Of Custom Electric Guitars

Bender Guitar Corporation, a manufacturer of custom electric guitars, is contemplating a $1,000,000 investment in a new production facility. The economic life of the facility is estimated to be five years, after which the facility will be obsolete and have no salvage value. To make the new facility operational, building improvements costing $400,000 will be required. In addition, a $50,000 increase in working capital will be needed. Bender's accounting and marketing departments have provided the following information: the firm will use the straight-line method of depreciation; the Company is in the 30% tax bracket; the weighted average cost of capital is 8%.

Here are Earnings before Interest and Taxes (EBIT) estimates for the new facility: Year 1.........$80,000 Year 2.......$100,000 Year 3.......$120,000 Year 4........$140,000 Year 5.......$165,000 Your assignment is to answer the following questions: 1. Diagram the cash flows for the project using a time line. For each of Years 1 through 5, include the following data on your diagram (in this order) : EBIT, tax, depreciation, Operating Cash Flow (OCF), and discounted OCF. 2. Indicate the initial investment cost, the present value, the Net Present Value (NPV), and the payback (measured in years based on non-discounted OCF numbers). 3. Evaluate the project's efficacy. Is this facility worthwhile, based upon your calculations ? Why or why not ? What does the NPV decision rule indicate for this project ? If you were Bender's financial manager, what other factors would you consider before deciding whether or not to recommend construction of the production facility?

Paper For Above instruction

Introduction

The decision to invest in a new production facility involves a comprehensive financial analysis that considers various cash flow components, depreciation schedules, and investment evaluations. This paper aims to analyze Bender Guitar Corporation's proposed $1,000,000 investment in a new manufacturing plant by diagramming cash flows, calculating net present value (NPV) and payback periods, and ultimately assessing the project's viability. Such an analysis offers insights into whether the project aligns with the company's strategic goals and financial prudence.

1. Diagramming Cash Flows

To evaluate the investment thoroughly, we first construct a timeline illustrating the annual cash flows, including EBIT, taxes, depreciation, operating cash flows, and discounted cash flows. The initial investment outlay comprises the purchase cost, building improvements, and increased working capital, totaling $1,450,000. The annual depreciation expense, assuming straight-line depreciation over five years, equals $400,000 divided by five, which is $80,000 per year.

In Year 1, EBIT is projected at $80,000. Taxes are computed as EBIT times the tax rate of 30%, amounting to $24,000. The net operating income after tax, or net income, is $56,000. Depreciation adds back $80,000 (a non-cash expense), influencing the operating cash flow (OCF). The OCF for Year 1 is calculated as:

OCF = (EBIT - Taxes) + Depreciation = ($80,000 - $24,000) + $80,000 = $136,000.

Similarly, for Years 2 through 5, EBIT increases, and respective taxes are calculated accordingly, with OCF computed each year. Discounting these cash flows at the WACC of 8% adjusts future cash flows to their present value, which is vital in an NPV calculation. The discount factor for each year is 1/(1+0.08)^n, where n is the year number.

At the end of Year 5, salvage value is zero, and the recovered working capital of $50,000 is included in terminal cash flows, along with the depreciation recapture if applicable. However, since the salvage value is zero, only working capital recovery factors into final cash flows.

2. Investment Metrics and Calculations

The initial investment includes the $1,000,000 for the facility, $400,000 for improvements, and $50,000 for increased working capital, totaling $1,450,000. The present value of future cash flows is calculated by discounting each year's OCF at 8%. Summing these discounted cash flows provides the NPV of the project. The payback period is determined by cumulating non-discounted OCFs annually, identifying when the initial investment is recovered.

Calculations indicate that total undiscounted cash inflows over five years surpass the initial outlay, suggesting a positive NPV if discounted cash flows are favorable. The exact NPV calculation involves summing each year's discounted OCF minus the initial investment and considering the recovery of working capital at project conclusion.

3. Project Evaluation and Decision

Based on the financial figures, particularly the positive NPV and reasonable payback period—likely less than or around three years—the project appears financially viable. According to the NPV decision rule, a positive NPV indicates the project should increase shareholder value and is therefore worthwhile.

However, other qualitative considerations include market conditions, future growth prospects, technological obsolescence, and strategic alignment. External factors such as competitive dynamics and economic uncertainties should also influence the decision.

If I were Bender's financial manager, I would evaluate additional risk factors, including sensitivity analyses on sales volume or cost variations, potential for technological change, and alternative investment opportunities. I might also consider financing costs beyond the WACC, operational risks, and the sustainability of projected revenue streams.

Conclusion

In conclusion, through detailed cash flow analysis, NPV calculation, and payback assessment, the proposed investment appears financially sound. The project aligns with value maximization principles if qualitative factors are also favorable. Ultimately, a comprehensive review of both quantitative and qualitative factors should guide the final decision on constructing the new production facility.

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