Elon Motors Course Project: Financial Analysis Of Equipment

Elon Motors Course Project: Financial Analysis of Equipment Investment

Elon Motors tasked its accounting and finance team with analyzing the financial viability of investing in new equipment. The project requires detailed calculations including cash flows, payback period, accounting rate of return, net present value, internal rate of return, and modified internal rate of return. The analysis involves assessing the costs and savings associated with purchasing versus making the equipment, considering depreciation, tax impacts, and cash flow implications over the equipment’s expected life span.

Paper For Above instruction

Investment decisions in manufacturing rely heavily on comprehensive financial analysis to determine the viability and profitability of purchasing new equipment. In the case of Elon Motors, a thorough evaluation involving multiple financial metrics such as cash flows, payback period, accounting rate of return (ARR), net present value (NPV), internal rate of return (IRR), and modified internal rate of return (MIRR) must be conducted to support a sound investment decision.

Introduction

The primary goal of capital budgeting is to assess whether a proposed investment, such as purchasing new manufacturing equipment, will result in increased value for the company. This evaluation involves estimating the incremental cash flows generated by the investment, understanding the initial outlay, and applying various financial analysis techniques. The analysis for Elon Motors will consider both the purchase and production options, their associated costs, and the long-term financial implications to determine the most beneficial course of action.

Cost and Financial Data Overview

The data provided indicates that the cost of new equipment is $1,570,000, with an expected lifespan of 10 years and a salvage value of $70,000. The equipment will be used to enhance manufacturing capacity, requiring 3 workers, each working 2,080 hours annually at $25 per hour. The company’s health benefit costs are 20% of wages, and direct materials cost $125 per unit, with annual needs totaling $375,000. Variable manufacturing overhead costs are $25 per unit, and the unit cost to purchase batteries is $325, with annual batteries requirements amounting to 3,000 units.

Depreciation and Tax Considerations

Using straight-line depreciation, the yearly depreciation expense equals the initial cost minus salvage value, divided by the useful life: ($1,570,000 - $70,000) / 10 = $150,000 annually. This depreciation expense provides tax savings and impacts net income calculations. Moreover, the effect on cash flows must incorporate tax implications, where a tax rate of 30% influences the after-tax cash flows.

Part 1: Cash Flows Over the Life of the Project

The annual after-tax cash flows comprise the cash savings resulting from cost reductions:

- Cost savings from avoiding purchase costs and realizing operational efficiencies.

- Tax savings from depreciation deductions.

The total annual after-tax cash flow is derived by summing these components, reflecting the ongoing benefits of the investment.

Part 2: Payback Period

The payback period calculates the time required for the initial investment to be recovered through the project's net cash inflows. For Elon Motors, this involves summing annual after-tax cash flows until they equal the initial outlay of $1,570,000. A shorter payback period signifies quicker recovery of capital and reduced investment risk.

Part 3: Accounting Rate of Return (ARR)

The ARR measures the profitability of the project based on accounting income, which is derived from annual cash savings less depreciation. The ARR is calculated as:

\[

\text{ARR} = \frac{\text{Average annual accounting income}}{\text{Initial Investment}}

\]

It provides a percentage-based measure of return, aiding in comparing investment opportunities.

Part 4: Net Present Value (NPV)

The NPV technique discounts future cash inflows and outflows to their present value using a required rate of return of 10%. The formula considers the initial purchase cost, annual cash savings, tax effects, and salvage value:

\[

NPV = \sum_{t=1}^{n} \frac{\text{Net cash flow}_t}{(1 + r)^t} - \text{Initial investment}

\]

A positive NPV indicates value creation, suggesting the project is financially sound.

Part 5: Internal Rate of Return (IRR) and Modified Internal Rate of Return (MIRR)

IRR is the discount rate that equates the present value of cash inflows to the initial investment. MIRR adjusts for the reinvestment of cash flows at a specific rate, often the company's cost of capital. Both metrics, calculated over a 10-year horizon, assist in comparing project profitability relative to other opportunities and risk factors.

Conclusion

The decision to purchase or produce equipment hinges on evaluating these financial metrics. If the project yields a positive NPV, an IRR exceeding the required rate of return, and a reasonable payback period, Elon Motors should consider proceeding with the investment. A comprehensive analysis, considering taxes, depreciation, and cash flows, enables an informed and financially prudent decision that aligns with the company's strategic objectives.

References

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