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Case 6

Robert Montoya, Inc.

Submitted to:
Ms. Balcos
Fin 105
Submitted by:
Rea Mae Caracena
Aimee Flordeliza
Christopher unsalan
Sarah !. Ro"as
1. #ncremental cash $o%s is de&ned as the additional cash $o% brou'ht about by a
pro(ect. More speci&cally it is the cash $o%s attributable to the pro(ect itsel).
#nterest e"penses are not included in the cash $o% statement* because i) it %as*
then the cost o) debt %ould be double counted. !his is because the discountin'
process already reduces the cash $o%s to account )or the pro(ect+s capital cost. #)
interest e"pense %as also subtracted )rom the cash $o%* then the cost o) debt
%ould be double counted.
,. !he -.00*000 that %as spent to rehabilitate the plant should not be included in
the analysis because it is already a sun/ cost that can no lon'er be reco0ered. 1e
are only interested in incremental CF+s
.. #) this %as true* the -.0*000 should be considered as an opportunity cost. !his
must be char'ed a'ainst the pro(ect* because it %ould ha0e been the cash $o%
'enerated i) the &rm didn+t proceed %ith the pro(ect.
2. !he net in0estment outlay is -,*500*000. !he terminal 0alue is -130*000. 4See
computations 2.15
5. 6pon computin' the pro(ect+s #RR* 78* and M#RR* it can be seen that the
pro(ect %on+t be pro&table. 1ith a net present 0alue belo% zero 49:;*<1;.;35* this
pro(ect %on+t create 0alue )or the company+s shareholders. Moreo0er* it+s #RR and
M#RR* :..,= and 3.0,=* respecti0ely* are belo% its cost o) capital. !hat means
this pro(ect doesn+t e0en ma/e enou'h to 'o o0er its hurdle rate. 4See
computations 2.15
<. !he de&nition o) incremental cash $o% %ould be di>erent i) the pro(ect in0ol0ed
a replacement rather than e"pansion. #n e"pansion* incremental CF is de&ned as
pro(ect+s cash in$o%s and out$o%s. !he company is comparin' the 0alue %ith and
%ithout the proposed pro(ect. #n replacement* incremental CF is de&ned as the
&rm+s additional in$o%s and out$o%s that result )rom in0estin' in the ne%
pro(ect. !he company is comparin' the 0alue i) it ta/es the ne% pro(ect 0ersus the
0alue i) it continues on e"istin' assets.
An e"ample %ould be seen in replacin' e?uipment* in doin' this* the 0alue o) the
old e?uipment should also be ta/en into account. @epreciation %ould be ne%ly
de&ned as the chan'e o) depreciation bet%een the installment o) ne% machine
0ersus continuin' the usa'e o) old machine. !his in e>ect %ould chan'e the cash
$o%s o) the pro(ect.
;. 1e belie0e the pro(ect+s CF+s are in nominal terms because they are too lar'e.
Assumin' a 5= in$ation* the latter CF+s %ould normally be less than the earlier
CF+s* but in our case they are relati0ely e?ual. !his can )urther be (usti&ed
because ta" shields on depreciation 4i) e0er there are5 do not increase %ith
in$ation and stay constant in nominal terms because most ta" la%s only allo% the
ori'inal cost o) the asset to be depreciated. !here)ore* the 1ACC should also be
in nominal terms.
!he 78 is biased because it o0erstates %hat may actually happen. !he economy
may $uctuate and decrease the real 0alue o) the CF+s because o) in$ation.
Ao%e0er* considerin' that it is only a 29year pro(ect* usin' nominal CF+s may not
really be a poor estimation o) %hat may actually happen.
:. 1hen in$ation is ta/en into account* the pro(ect+s 78* #RR* M#RR and paybac/
are the )ollo%in': -5<<*:5<.:,* 13.:.=* 15.;;= and ,.<2 years 4See !able :.19
:..5. 1e can see that the indicators ha0e impro0ed. !hese &'ures imply that the
pro(ect becomes more 0iable %hen in$ation is considered.
3. !he sin'le cycle 78 o) ro(ects S and B are -1<*5,:.3. and -,2*;<1.3; 4!able
3.15. Because the 78s are computed %ith di>erent time spans* these 0alues
cannot be used to assess the pro(ects. C0en %ith di>erent li0es* ma/in' the
necessary ad(ustments can ma/e the t%o pro(ects comparable. 6sin' the
replacement chain approach* the 78 o) ro(ects S and B are -.0*1:3.13 and
-,2*;<1.3; 4!able 3..5. !he e?ui0alent annuities o) the pro(ects are -3*5,..:1 and
-;*:11.<:* respecti0ely 4!able 3.,5.
Based on these indicators* ro(ect S is the better option %hen the cost o) rene%in'
the pro(ect is the same. #t yields a hi'her 78* -5*2,;.,, more than ro(ect B.
1hen the pro(ects are e"tended to a common li)e o) )our years* ro(ect S %ill yield
-1*;1,.1. more in terms o) annuities.
But i) the cost o) rene%in' ro(ect S is -2*,00*000* ro(ect B is more pro&table
%ith an 78 that 'i0es -11*101.;0 more than ro(ect S 4!able 3.25.
10. #) the truc/ is used )or three years* its 78 is - 4.*,3<.;;5. #) it is used )or t%o
years and sold* its 78 is -;<0.... #n the same %ay* the 78 o) the truc/ is -
45*030.315 i) used only )or a year and then sold. 4see !ables 10.1 and 10.,5 !hese
0alues are computed assumin' that the Cnd9o)9Dear 7et Abandonment Cash Flo%s
pro0ided are a)ter9ta" &'ures. !his means that it is best to use the truc/ only )or
t%o years and sell it. A)ter t%o years* the &rm has earned enou'h )rom the truc/
and at the same time* is able to sell it at a reasonable price. !he economic li)e o)
the truc/ is , years. !his is because it is only at this time %hen the pro(ect %ill
turn out to be pro&table )or the company. Cconomic li)e is de&ned as the span o)
years it ta/es )or an in0estment to brea/ e0en.
a. 4See !able 11.15. 6pon ta/in' into account the said cash cost and sales price
in$ation o) 5= per year* the pro(ect+s net present 0alue is no% positi0e at
-10,*.53* thus ma/in' the pro(ect )a0orable to the &rm+s shareholders. !he
positi0e net present 0alue is due to the hi'her net cash $o%s at the end o) years ,
to 2. !his increase in the cash $o%s also causes the pro(ect+s #RR to become
11.30=. !hus* e"ceedin' the pro(ect+s cost o) capital. !he pro(ect+s M#RR also
increases to 11.11=* also abo0e the 10= cost o) capital. Moreo0er* a)ter in$ation*
the pro(ect+s paybac/ period decreased to ..0<. Aence* the neutral in$ation
increased the pro(ect+s pro&tability.
b. #) this happens* the pro(ect %ould be e0en more unpro&table than it %as %ithout
the in$ation. #ts net present 0alue %ould )urther decrease to 92;:*,<...0*
indicatin' that it %ould pull the &rm do%n instead o) addin' 0alue to it. Moreo0er*
its un9pro&tability can also be seen %ith its #RR o) 0.02=* %hich is %ay belo% the
pro(ect+s cost o) capital. #ts M#RR o) 2..1= %hich is belo% its M#RR %ithout
in$ation 43.0,=5* also indicates that the pro(ect is %orse o> than it %as %ithout
in$ation. !his happens because %ith the increase in the cash costs* the pro(ect+s
pro&t mar'in decreases* thus pullin' the net cash $o%s do%n%ard.
a. #) in$ation rates %ere 5= on prices and ,= on cash costs* the company could
sell the units at -.3 each in order to brea/9e0en. 4See !able 1,.15
b. #) cash costs increase by 5= annual in$ation %ithout a correspondin' increase in
sales prices* the company %ould ha0e to sell 113*0:< units in order to brea/9e0en.
4See !able 1,.,5