CASE STUDY REPORT
EMGT 6225 – Economic Decision Making
NIVEDITA HARISHCHANDRA TODKAR
NUID: 002197330
SUBMISSION DATE APRIL 16, 2023
Sr. No.
Table of Contents
Page No.
I
Case Study Description
2
II
Options
3
III
Step 1: Cash Flow Construction
3
IV
Step 2: Calculate MARR
4
V
VI
VII
VIII
IX
X
Step 3: Construct the Before Tax Cash Flow
Step 4: Economic Worth Calculation
Step 5: Calculate the Annual Income Tax
Step 6: After Tax Calculation
Step 7: After Tax Calculation After Inflation
Conclusion
5
5
6
6
7
7
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I. CASE STUDY DESCRIPTION
A $8M investment is considered by an electric bike manufacturing company to add
a new production line for its new product, electric skateboards. The company has
commissioned an exploratory study of where to place the new production line and
which type of equipment to use. There are three types of machines to choose from
for the company to install on the new assembly line. The machines have zero
salvage value at the end of 10-year planning horizon. The company must select at
least two alternatives from (i) Loan, (ii) Common Stocks, (iii) Preferred Stocks,
and (iv) Retained Earnings to obtain the required amount of capital for the
investment. Each of these capital sources could provide $4M to support the
project. The company is anticipating rapid product penetration and aggressive
growth after addition of the new production line. The major question for this case
study is to find out if the project is economically justified.
To check if the project is economically feasible, the following steps were taken for analysis:
Step 1: Cash Flow Construction
Step 2: Calculate MARR
Step 3: Construct the Before Tax Cash Flow
Step 4: Economic Worth Calculation
Step 5: Calculate the Annual Income Tax
Step 6: After Tax Calculation
Step 7: After Tax Calculation after Inflation
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II. OPTIONS
1. Capital Sources:
a) Preferred Stock:
Dividend = $7, Price = $100, Brokerage Fee = $3
b) Loan:
Interest Rate = 8%, Compounded Semi Annually
Payback Method: Plan 3
2. Machine:
Machine 1:
Number of Machines = 20
First Cost = $200,000
Operating Cost/Hr. =$120
Revenue/Hr. = $170
Hr./Year = 1500 Hrs.
Useful Life = 10 Years
Depreciation (MACRS) = 5 Years
3. Tax Rate:
a) State Tax Rate: 9%
b) Federal Tax Rate: 19%
4. Inflation: 5%
III. CASH FLOW CONSTRUCTION
To construct the cash flow, we can start by calculating Weighted Average Cost of Capital
(WACC)
To calculate WACC, we decided to use 2 capital sources: Preferred Stocks and Loan.
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Each of the capital sources could provide $4M to support the project which means both the
sources contribute 50% to the investment (i.e., weight for each is 50%). The cost of capital for
each capital source was calculated which comes out as follows:
Preferred Stock: 7.22%
Loan: 5.71%
Using the weight and capital costs of both the sources, we calculate WACC = 6.46%
Table 1: Loan and WACC calculation
IV. CALCULATE MARR
Using WACC, we can calculate the Minimum Acceptable Rate of Return (MARR) which is
11% for the planning horizon of 10 years.
Table 2: Calculation of MARR
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V. CONSTRUCT THE BEFORE TAX CASH FLOW
The number of machines is 20, where first cost is $200,000. Therefore, the total cost of
machines is $4M. Since we get 50% from Preferred stocks and 50% from loans, we get
$2,000,000 from each of the sources.
The Before Tax Cash flow is as follows:
Table 3: Calculation for Before Tax Cash Flow
After constructing the before tax cash flow, we can see that the payback plan results in a
payment of $300,213.54/year for a 10-year planning horizon. Operating cost for each year is
$3,600,000 and revenue is $5,100,000.
VI. ECONOMIC WORTH CALCULATION
To find the economic worth, we calculated the Present Worth (PW), Discounted Payback
Period (DPBP) and Internal Rate of Return (IRR) which are as follows:
Table 4: Calculation for economic worth
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VII. CALCULATE THE ANNUAL INCOME TAX
The state tax rate is 9% and federal tax rate is 19%, therefore the income tax is 26% as follows:
Table 5: Calculations for tax
VIII. AFTER TAX CALCULATION
To construct the After-Tax Cash Flow, we first calculate the interest of the loan on which tax
must be deducted every year is calculated.
Using MACRS for 5 years, the depreciation amount is calculated for each year after which the
taxable income (TI) is calculated. We then deduct tax from before tax cash flow which gives
us the following after tax cash flow:
Table 6: Calculation of ATCF: PW, AW, IRR (Before inflation)
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IX. AFTER TAX CALCULATION AFTER INFLATION
Using the inflation rate of 5%, we calculate the inflated amount, the taxable income (TI) and
tax which gives us the following cash flow:
Table 7: Calculation ATCF: PW, AW, IRR (After inflation)
X. CONCLUSION
After the economic analysis, we can conclude that as the IRR and ERR values are greater
than WACC and PW is positive, the company’s project to set up a new production line for
the new product is economically justified.
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