Case 21
- Submitted by: Bandismokes
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- Category: Arts
- Date Submitted: 02/21/2012 10:13 AM
- Pages: 5
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Executive Summary
Engineering Products PLC is considering the purchase of a new CNC milling machine costing £240,000 and with a four-year life. Management’s expectations are that the revenue generated by the new machine should cover the initial investment within a period of 3 years and with a 16% return on EBIDTA over investment.
From the assessment using the metrics Payback, ROI, NPV and IRR, it indicates that the project has merits and should be pursued. A sensitivity analysis is also conducted on the two main contributors of cash flow, namely revenue and cost of goods sold.
Case Evaluation Outline
In evaluating the purchase of the CNC milling machine, we will first have to determine the relevant cash flows that is required for the investment. Brealey et al (2008) states some ground rules that will have to be noted. They are:
1. Only Cash Flow is relevant
2. Forgot sunk costs
3. Include all Incidental Effects
4. Include Opportunity Costs
With the above-mentioned in mind, we can now identify the cash flow that are relevant and to calculate the metrics to make the purchase decision. However, because the irrelevant cash flow number lesser than the relevant ones, only the irrelevant ones are listed below to eliminate them from the calculations.
|Cash Flow Type |Reason |
|Other production expenses with overheads equal |Sunk costs - None of the overheads were incurred as a result of the proposal |
|to 20% of labour | |
|Labour Costs & |Sunk costs – will be incurred even if company doesn’t purchase the new CNC |
|Administration Charge |milling machine |
|Interest on loans...
Engineering Products PLC is considering the purchase of a new CNC milling machine costing £240,000 and with a four-year life. Management’s expectations are that the revenue generated by the new machine should cover the initial investment within a period of 3 years and with a 16% return on EBIDTA over investment.
From the assessment using the metrics Payback, ROI, NPV and IRR, it indicates that the project has merits and should be pursued. A sensitivity analysis is also conducted on the two main contributors of cash flow, namely revenue and cost of goods sold.
Case Evaluation Outline
In evaluating the purchase of the CNC milling machine, we will first have to determine the relevant cash flows that is required for the investment. Brealey et al (2008) states some ground rules that will have to be noted. They are:
1. Only Cash Flow is relevant
2. Forgot sunk costs
3. Include all Incidental Effects
4. Include Opportunity Costs
With the above-mentioned in mind, we can now identify the cash flow that are relevant and to calculate the metrics to make the purchase decision. However, because the irrelevant cash flow number lesser than the relevant ones, only the irrelevant ones are listed below to eliminate them from the calculations.
|Cash Flow Type |Reason |
|Other production expenses with overheads equal |Sunk costs - None of the overheads were incurred as a result of the proposal |
|to 20% of labour | |
|Labour Costs & |Sunk costs – will be incurred even if company doesn’t purchase the new CNC |
|Administration Charge |milling machine |
|Interest on loans...