Answer:
Introduction
By using the information given for Mr. Walker about his company, this report is prepared to analyze the viability and to give some recommendation about a new production line for two different sizes of pipes in Delaware Pipe.
Delaware Pipe is a company with more than 29 years of background in the pipe market to producing three used sizes of PVC pipe, 3 in, 6 in and 8 in. The company has performed very well in the last year only with these three production lines. However, two other sizes are demanded by the customers, where until the present moment the company have purchased these goods from another company and have sold them.
Company’s owner, Mr. Walker’s has provided relevant information about the company and the marketplace of the firm. In addition, the accountant of the Delaware Pipe has prepared a cost estimation for this production line, which resulted in an unfeasible project for the company.
In the context of project evaluation, using NPV as one of the evaluation’s method, this report will show if the project is consistent with the firm goals. Furthermore, a complementary revision in the accountant’s number will be presented.
Analysis
This section entails detailed analysis of the two options, i.e. producing the pipes internally or buying them. The financial analysis techniques such as Payback Period (PBP), Net Present Value (NPV), Internal Rate of Return (IRR) and Profitability Index (PI) have been considered in the analysis based on the three scenarios i.e. Worst Scenario, Most Likely, and Best.
Question One
Exhibit 1: Probability Scenarios table
Scenario 
Annual Sales (lbs) 
Probability 
Worst 
1,350,000 
0.1 
Most Likely 
1,650,000 
0.6 
Best 
2,250,000 
0.3 

Exhibit 2: Depreciation Rates for MACRS Property
Year 
Rate 
1 
14.30% 
2 
23.50% 
3 
16.20% 
4 
11.50% 
5 
8.90% 
6 
8.90% 
7 
8.90% 
8 
4.60% 
9 
3.20% 

Annual Cost of internal production 10in and 12in (Accountant estimation)
1 
Raw material 
$544,500 
2 
Distribution cost 
$33,000 
3 
Direct labour 
$40,000 
4 
Indirect labour 
$8,000 
5 
On costs 
$11,520 
6 
Utilities 
$8,000 
7 
Repairs and Maintenance 
$7,000 
8 
Space 
$6,600 
9 
General factory 
$18,000 
10 
Depreciation 
$125,000 
11 
Lost interest 
$120,000 

TOTAL 
$921,620 
Net present value (NPV) is a financial tool used to determine whether or not a given project proposal is feasible for investment. A project is feasible if it yields a positive NPV. It is calculated by deducting the initial cash outlay from the discounted cash inflow. Therefore when calculating the Net Present Value the flowing items should be included;
 The projected cash flow (s).
 The Initial cash outlay: This is the original cost to be incurred if the proposed project is chosen;
 And, the discount rate based on the company’s costof capital.
Exhibit 3 items comprise of the costs to be incurred in implementing the new production line. Therefore, the total net cash flows (after tax) should be calculated. Conversely, the loss interest of $120,000 incurred in purchasing the equipment is accounted as the discounting rate and hence should not be included in the NPV’s cash flows (Sekar, Gowri, & Ramya, 2014). Depreciation is included in the calculation of the cash flows because it affects the company’s tax bill. That is, depreciation is deducted from the revenue to obtain the taxable income and then added back to the cash flow after tax. Additionally, the list excludes both the initial cash outlay and discounting rate. Residual value is also included in the discounted cash flow after tax (Gitman, Juchau, & Flanagan, 2011).
Item 3 (Direct labour) and Item 4 (Indirect labour) should be excluded from the computation of the cash flow. Currently, the company is overstaffed and two employees will be retired at the end of three years so as to employ two new ones. The direct labour cost of the employees taken care of and should not be doublededucted. The same case should be considered in treating indirect labour. The plant manager will not be paid an extra amount to supervise the new plant (Deegan, 1960 2013). Since Items (3) and (4) do not apply, the item (5) should be zero. It is not clear whether or not the item (8) represents the current utility cost incurred by the company. Likewise, item (8) on space cost should be excluded because Delaware already has enough space to erect the plant (emeraldinsight, 2017).
Question Two: the incremental cash flow table
The incremental cash flow refers to the additional net cash flow that Delaware will generate by investment in the new product line. It is obtained by deducting the initial cash outlay from the expected new revenue from the new investment (Sekar, Gowri, & Ramya, 2014).
On the other hand, initial cash outlay is obtained from the difference between all the cash outflows and inflows at the beginning of the period (i.e. time zero). Walker disclosed that the total initial cost of equipment is $ 1,000,000 while its useful life is 8 years. Likewise, the inventories will increase by 10% of the annual sales (Peirson, Brown, Easton, Howard, & Pinder, 2015).
Therefore the projected sales and expenses are as follows per annum
sales price 
$0.56 
annual sales 
$924,000 
volume of sales 
1,650,000 
Annual Expenses 

1. Raw materials ($ 0.33 x 1,650,000) 
$544,500 
2. Distribution cost ($ 0.02 x 1,650,000) 
$33,000 
3. Direct labour (company overstaffed) 
$0 
4. Indirect labour (plan manager already in company) 
$0 
5. On cost (% of items 3 and 4) 
$0 
6. Utilities (cost already incurred) 
$8,000 
7. Repairs and Maintenance 
$7,000 
8. Space (space already available) 
$0 
9. General factory (cost already incurred) 
$0 
10. Depreciation (excluded) 
$0 
11. Lost interest (excluded) 
$0 

$592,500 
Delaware Pipe  cash flows 




Tax rate 
30% 



Residual value 
$150,000 



Machine cost 
$1,000,000 



Change in net working capital (Inventory) 
$1,016,400 
increased in 10% of annual sales 

Annual sales 
$924,000 
the most likely scenery 


Annual expenses 
$592,500 




Year 0 
Year 1 
Year 2 
Year 3 
Year 4 
Year 5 
Year 6 
Year 7 
Year 8 
Machine cost 
$1,000,000 








Inventory 
$1,016,400 







$1,016,400 
Aftertax Annual sales 

$646,800 
$646,800 
$646,800 
$646,800 
$646,800 
$646,800 
$646,800 
$646,800 
Aftertax Annual expenses 

$414,750 
$414,750 
$414,750 
$414,750 
$414,750 
$414,750 
$414,750 
$414,750 
Depreciation  machine 

$143,000 
$235,000 
$162,000 
$115,000 
$89,000 
$89,000 
$89,000 
$78,000 
Residual value 








$150,000 
Tax on disposal gain (machine) 








$45,000 
Aftertax Net cash flows 
$2,016,400 
$375,050 
$467,050 
$394,050 
$347,050 
$321,050 
$321,050 
$321,050 
$1,431,450 
Question Three: Decision Techniques
Note: Rate of Return= 10%.
 Net Present Value (NPV)
10% Rate of Return 

Year 
Cash Flow 
PVIF 
Cash Inflow 
1 
$375,050 
0.909 
340920.45 
2 
$467,050 
0.826 
385783.3 
3 
$394,050 
0.751 
295931.55 
4 
$347,050 
0.683 
237035.15 
5 
$321,050 
0.621 
199372.05 
6 
$321,050 
0.564 
181072.2 
7 
$321,050 
0.513 
164698.65 
8 
$1,431,450 
0.467 
668487.15 

Total Discounted Cash Inflow 
2473300.5 


Less: Initial Cash Outflow 
2016400 


NPV 
456,900.50 
Payback Period
Year 
Cash Flow 
Cumulative Cash flows ($) 

0 
Cash Outflow 

2,016,400 
1 
$375,050 
375,050 
1641350 
2 
$467,050 
842,100 
1174300 
3 
$394,050 
1,236,150 
780,250 
4 
$347,050 
1,583,200 
433,200 
5 
$321,050 
1,904,250 
112,150 
6 
$321,050 
2,225,300 
208,900 
7 
$321,050 
2,546,350 
529,950 
8 
$1,431,450 
3,977,800 
1,961,400 
Payback=5 years + = 5.35 years
 Internal Rate of Return (IRR)
IRR refers to the discounting rate when NPV is Zero (0). For the purpose of this study, the trial and error method will be used to calculate IRR.
IRR= LDR + ()*(HDRLDR)
Note:
LDR= Lower Discounting Rate
HDR= Higher Discounting Rate
NPV of IRR= 0
The NPV at 10 %( LDR) is 456,900.50. Let us try to calculate NPV at 20% (HDR).
NPV at 20% is;
20% Rate of Return 

Year 
Cash Flow 
PVIF 
Cash Inflow 
1 
$375,050 
0.833 
312416.65 
2 
$467,050 
0.694 
324132.7 
3 
$394,050 
0.579 
228154.95 
4 
$347,050 
0.482 
167278.1 
5 
$321,050 
0.402 
129062.1 
6 
$321,050 
0.335 
107551.75 
7 
$321,050 
0.279 
89572.95 
8 
$1,431,450 
0.233 
333527.85 

Total Discounted Cash Inflow 
1691697.05 


less: Initial Cash Outflow 
2016400 


NPV 
324,702.95 
Therefore IRR is;
IRR= 10% + ()*(20%10%)
=10%+ ()*(10%)
= 10% + (0.51*10%)
=IRR= 10% +5.10%
=IRR= 15.10%
 Profitability Index (PI)
Decision Criteria
According to the NPV, a single propjet should be accepted or rejected is the NPV is greater than zero or less than zero respectively. In this case, the NPV is $ 456,900.50 hence the new plant should be accepted.
According to Payback Period, a single project should be accepted if the period obtained is below or equal to the one set by the management. The company’s payback period is 5 years. However, it would take approximately 5 years and 4 months for the company to recover the initial cash outlay. Under strict adherence to the desired payback period, the project should be rejected. However, four months is a shorter period and the project should be accepted (Deegan, 1960 2013).
According to the IRR technique, the projected should be accepted if the IRR is greater than the cost of capital. In this case, the IRR is 15.1% while the Cost of Capital is 10%. Therefore the project should be accepted.
According to the PI technique, a project should be accepted if the PI is greater than 1. From the calculation, the PI is 1.227 hence the proposed project should be accepted.
Therefore, investing in the new production line for 10 and 12inch pipes should be accepted because all the methods show positive results (Sekar, Gowri, & Ramya, 2014).
Question 4: Sensitivity analysis of NPV to sales quantity
Considering the worst and bestcase scenarios

Tax rate 
30% 



Aftertax RRoR 
10% 



Residual value 
$150,000 



Machine cost 
$1,000,000 



Change in net working capital (Inventory) 
$831,600 



Annual sales 
$756,000 
worst scenery 


Annual expenses 
$592,500 



Year 0 
Year 1 
Year 2 
Year 3 
Year 4 
Year 5 
Year 6 
Year 7 
Year 8 
Machine cost 
$1,000,000 








Inventory 
$831,600 







$831,600 
Aftertax Annual sales 

$529,200 
$529,200 
$529,200 
$529,200 
$529,200 
$529,200 
$529,200 
$529,200 
Aftertax Annual expenses 

$414,750 
$414,750 
$414,750 
$414,750 
$414,750 
$414,750 
$414,750 
$414,750 
Depreciation  machine 

$143,000 
$235,000 
$162,000 
$115,000 
$89,000 
$89,000 
$89,000 
$78,000 
Residual value 








$150,000 
Tax on disposal gain (machine) 








$45,000 
Aftertax Net cash flows 
$1,831,600 
$257,450 
$349,450 
$276,450 
$229,450 
$203,450 
$203,450 
$203,450 
$1,129,050 
The NPV is calculated as;
Year 
Cash Flow 
PVIF 
Cash Inflow 
1 
$257,450 
0.909 
234022.05 
2 
$349,450 
0.826 
288645.7 
3 
$276,450 
0.751 
207613.95 
4 
$229,450 
0.683 
156714.35 
5 
$203,450 
0.621 
126342.45 
6 
$203,450 
0.564 
114745.8 
7 
$203,450 
0.513 
104369.85 
8 
$1,129,050 
0.467 
527266.35 

Total Discounted Cash Inflow 
1759720.5 


less: Initial Cash Outflow 
1831600 


NPV 
71,879.50 
The NPV at the worst scenario is approximately negative 72,000.
 b) Best Scenario
Tax rate 
30% 



Aftertax RRoR 
10% 



Residual value 
$150,000 



Machine cost 
$1,000,000 



Change in net working capital (Inventory) 
$1,386,000 



Annual sales 
$1,260,000 
best scenery 

Annual expenses 
$592,500 




Year 0 
Year 1 
Year 2 
Year 3 
Year 4 
Year 5 
Year 6 
Year 7 
Year 8 

Machine cost 
$1,000,000 









Inventory 
$1,386,000 







$1,386,000 

Aftertax Annual sales 

$882,000 
$882,000 
$882,000 
$882,000 
$882,000 
$882,000 
$882,000 
$882,000 

Aftertax Annual expenses 

$414,750 
$414,750 
$414,750 
$414,750 
$414,750 
$414,750 
$414,750 
$414,750 

Depreciation  machine 

$143,000 
$235,000 
$162,000 
$115,000 
$89,000 
$89,000 
$89,000 
$78,000 

Residual value 








$150,000 

Tax on disposal gain (machine) 








$45,000 

Aftertax Net cash flows 
$2,386,000 
$610,250 
$702,250 
$629,250 
$582,250 
$556,250 
$556,250 
$556,250 
$2,036,250 
Year 
Cash Flow 
PVIF 
Cash Inflow 
1 
$610,250 
0.909 
554717.25 
2 
$702,250 
0.826 
580058.5 
3 
$629,250 
0.751 
472566.75 
4 
$582,250 
0.683 
397676.75 
5 
$556,250 
0.621 
345431.25 
6 
$556,250 
0.564 
313725 
7 
$556,250 
0.513 
285356.25 
8 
$2,036,250 
0.467 
950928.75 

Total Discounted Cash Inflow 
3900460.5 


less: Initial Cash Outflow 
2386000 


NPV 
1,514,460.50 
The NPV at the best scenario is approximately 1,514,460.50.
The NPV at the worst scenario is negative while the NPV at the best scenario shows promising returns. There are the best parameters to evaluate the variation of the returns either way. Therefore, Delaware should consider the most likely scenario because it produces the most realistic results.
Question 5: The project’s expected NPV, standard deviation, and coefficient of variation
 The Expected Return: Is calculated by multiplying the Expected NPV with Probability.

Sales volume 
Probability 
Sales x Prob. 

Worst 
1,350,000 
0.1 
525,000 

Most Likely 
1,650,000 
0.6 
3,150,000 

Best 
2,250,000 
0.3 
1,575,000 


5,250,000 

5,250,000 

Using the figures found in questions 3 and 4 



Rate of Return 
Probability 
Weighted Value 

Worst 
0.091 
0.1 
0.009 

Most Likely 
0.151 
0.6 
0.091 

Best 
0.236 
0.3 
0.071 



1.0 
0.170 
Therefore, the expected return is 0.17 or 17%.
 Standard deviation

R  E ( R ) 
(R E(R))2 
Pi 
Variance 
Std Deviation 
Worst 
0.082 
0.007 
0.1 
0.001 

Most Likely 
0.060 
0.004 
0.6 
0.002 

Best 
0.165 
0.027 
0.3 
0.008 




1.0 
0.011 
0.105 
The standard deviation is 0.105 or 10.5%.
 the coefficientof variation
Coefficient of Variation (CV) = CV= Std Deviation / Expected Return
= 0.105/ 0.17
= 0.62
The expected revenue, standard deviation and the coefficient of Variation are techniques used represent security or portfolio of the investment. Standard deviation is meant to measure the degree of risks associated with the project returns. A good investment should offer minimum risk for a certain return level or maximum returns for a certain risk level.
The new product line has a standard deviation of 10.5% which represent risks. Likewise, the probability of dispersion is 0.62. The probability of dispersion associated with the three scenarios is insignificantly spread hence there is less risk or variability associated with the return (Gitman, Juchau, & Flanagan, 2011).
Question 6: The minimum annual increase
The minimum annual increase refers to the project’s breakeven point i.e. a number of sales that is required to cover the cost.
option 1: buy and resell 


selling price 

$0.56 
total cost ($0.45 product + $0.02 distribution cost) 
$0.47 

margin 

$0.09 
option 2: internal production 


variable costs: 
$0.35 

raw material 
$0.33 

distribution cost 
$0.02 

sales price 
$0.56 

contribution margin 
$0.21 

Aftertax Annual expenses 
$10,500.00 

the volume of sales 
50,000 

Annual sales 
$28,000.00 

total costs ($0.35*50,000+$10,500) 
$28,000.00 

Assuming: 





(1) only materials and distribution costs will vary with increased production 

(2) no additional equipment is needed 



(3) unit selling price is 56 cents per pound; 



(4) The relevant aftertax discount rate is 12 percent. 


Tax rate 
30% 

Aftertax RRoR 
12% 

Residual value 
$0 

Machine cost 
$0 

Change in net working capital (Inventory) 
$30,800 

Annual sales 
$28,000 

Annual expenses 
$15,000 


Year 0 
Year 1 
Year 2 
Year 3 
Year 4 
Year 5 
Year 6 
Year 7 
Year 8 

Machine cost 
$0 









Inventory 
$30,800 







$30,800 

Aftertax Annual sales 

$19,600 
$19,600 
$19,600 
$19,600 
$19,600 
$19,600 
$19,600 
$19,600 

Aftertax Annual expenses 

$10,500 
$10,500 
$10,500 
$10,500 
$10,500 
$10,500 
$10,500 
$10,500 

Depreciation  machine 

$0 
$0 
$0 
$0 
$0 
$0 
$0 
$0 

Residual value 








$0 

Tax on disposal gain (machine) 








$0 

Aftertax Net cash flows 
$30,800 
$9,100 
$9,100 
$9,100 
$9,100 
$9,100 
$9,100 
$9,100 
$39,900 

Payback  balance outstanding 

$21,700 
$12,600 
$3,500 
$5,600 
$14,700 
$23,800 
$32,900 


Net present value (NPV) 
$26,845 


Internal rate of return (IRR) 
29.55% 


Profitability index (PI) 
1.872 


Payback period (PP) 
3.385 
years 
The cash flow created at a minimum sales volume also shows good results. For instance, the NPV is $ 26,845, the internal rate of return is 29.55% which is higher compared to the 12% cost of capital. Moreover, the profitability index is 1.872 while it would only take the company 3.385 years to recover the initial cash outlay.
Question 7: Does higher discounting rate make sense
Using the company’s current cost of capital in evaluating the new product line of 10in and 12in pipes, simply states that the company does not expect the risks associated with its operations to increase. However, considering the volatility in the business environment, factors such as an increase in inflation and interest rates to increase. The current cost of capital should only be applied when the company is sure that the operating expenses would not increase.
However, with the anticipated increase of inflation by 3% as well as other risks, the company is in order to increase its discounting rate to 12%. It would still be justifiable if the rate is further increased to 15% (Sekar, Gowri, & Ramya, 2014).
Recommendation based on questions 17
Based on the calculations and analysis Delaware should invest in building the 10in and 12in pipes internally. From the most likely scenario, the project will have a positive NPV of $ 456,744 while the IRR will be 15.10%. Likewise, the Company has the required space, personnel and resources to build the new plant. Considering these factors the project is feasible and should be invested in (Peirson, Brown, Easton, Howard, & Pinder, 2015).
Conclusion
By using the information given for Mr. Walker about his company, this report has been prepared to analyze the viability of the proposed investing in the building of new pipe production plant. The company have purchased these goods from another company and later sell them.
Company’s owner, Mr. Walker’s has provided relevant information about the company and the marketplace of the firm. In the context of project evaluation, techniques such as NPV, IRR, Payback Period, and PI have been used to evaluate the project. The results have shown positive results hence the company should invest in it. Likewise, the report has shown that the project is consistent with the firm goals. Furthermore, Delaware has the required resources, space, and personnel to successfully implement the proposed project.
Recommendations
The Company should go on and implement the development of the 10in and 12in pipes project. The recommendation is based on the positive results obtained from the analysis. NPV, IRR, and PI show positive results. Although the Payback period obtained is higher than 5 years, it should be accepted because the variation period is short: Just for months only. Therefore, we agree that the company should invest in the project.
In this section, clearly, state what course of action you recommend and justify your decisions. Include as many recommendations as you need to.
References
Deegan, C. (1960 2013). Financial accounting theory (4th Edition ed.). North Ryde, N.S.W: McGrawHill Education.
emeraldinsight. (2017). Property Investment and Finance. Journal of Property Investment & Finance, 35(5).
Gitman, L., Juchau, R. H., & Flanagan, J. (2011). Principles of managerial finance. Frenchs Forest: Pearson Australia.
Peirson, G., Brown, R., Easton, S., Howard, P., & Pinder, S. (2015). Business finance. Sydney: McGraw Hill.
Sekar, M., Gowri, M., & Ramya, G. (2014). A Study on Capital Structure and Leverage of Tata Motors Limited: Its Role and Future Prospects. Procedia Economics and Finance, 11, 445458.
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