Integrative Problem 10-1 Unilate Textiles is evaluating a new product, a silk/woolblended fabric. As

Integrative Problem 10-1 Unilate Textiles is evaluating a new product, a silk/woolblended fabric. Assume that you were recently hired as assistant tothe director of capital budgeting, and you must evaluate the newproject. The fabric would be produced in an unused building adjacent toUnilate’s Southern Pines, North Carolina plant. Unilate owns thebuilding, which is fully depreciated. The required equipment wouldcost $200,000, plus an additional $40,000 for shipping andinstallation. In addition, inventories would rise by $25,000, whileaccounts payable would go up by $5,000. All of these costs would beincurred at Year 0. By a special ruling, the machinery could bedepreciated under the MACRS system as 3-year property. (See Table10A.2 at the end of Chapter 10 for MACRS recovery allowancepercentages.) The project is expected to operate for four years, at which timeit will be terminated. The cash inflows are assumed to begin oneyear after the project is undertaken, or at t = 1, and to continueout to t = 4. At the end of the project’s life (Year 4), theequipment is expected to have a salvage value of $25,000. Unit sales are expected to total 100,000 five-yard textile rollsper year, and the expected sales price is $2 per roll. Cashoperating costs for the project (total operating costs lessdepreciation) are expected to total 60% of dollar sales. Unilate’smarginal tax rate is 40%, and its required rate of return is 10%.Tentatively, the silk/wool blend fabric project is assumed to be ofequal risk to Unilate’s other assets. You have been asked to evaluate the project and to make arecommendation as to whether it should be accepted or rejected. Toguide you in your analysis, your boss gave you the following set oftasks to complete: Draw a cash flow time line that shows when the net cash inflowsand outflows will occur, and explain how the time line can be usedto help structure the analysis. Unilate has a standard form that is used in the capitalbudgeting process and shown in the following table:          Unilate’sSilk/Wool Fabric Project ($ Thousands)          End ofYear:                                                               0                        1                             2                        3                   4              Unit sales(Thousands)                                                                                                      100                                                       Price/unit                                                                                               $ 2.00                $ 2.00                                                         Totalrevenues                                                                                                                                           $200.0                               Costs excludingdepreciation                                                                                    ($120.0)                                                      Depreciation                                                                                                                                                ( 36.0)         ( 16.8)         Total operatingcosts                                                                   ($199.2)            ($228.0)                                                         Earnings before taxes(EBT)                                                                                                                 $44.0        Taxes                                                                                                   (     0.3)                                                                  25.3         Netincome                                                                                                                                                    $26.4      Depreciation                                                                                           79.2                                               36.0                                 SupplementaloperatingCF                                                          $ 79.7                                                                $ 54.7       Equipment cost       Installation       Increase in inventory       Increase in accounts payable       Salvage value       Tax on salvage value       Return of net workingcapital                                                                                                                                                            Cash flow timeline (net CF):                            ($260.0)                                                                                         $ 89.7       Cumulative CF forpayback:                              (260.0)           (180.3)                                                                      63.0                                        NPV =                                          IRR =                                 Payback = Complete the table in the followingorder: Complete the unit sales, sales price, total revenues, andoperating costs excluding depreciation lines. Complete the depreciation line. Now complete the table down to net income and then down to netoperating cash flows. What are the advantages anddisadvantages of focusing on a project’s market risk? . . .

 

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