Should Francesca Cerini Proceed With The Project Management Essay

Please assess the economic benefits of acquiring the Vulcan Mold-Maker machine. What is the initial outlay. What is an appropriate discount rate. Does the net present value (NPV) warrant the investment in the machine?

2. What uncertainties or qualitative considerations might influence your recommendation? How, if at all, would an inflation rate of 3 percent (or higher) affect the attractiveness of the Vulcan Mold-Maker? Please estimate the impact on NPV from a change in any of these elements.

3. Should Francesca Cerini proceed with the project?

Overview

Fonderia di Torino (Fdt) produces specialised metal castings for the automotive automotive, aerospace and construction industries. FdT’s managing director is Francesca Cerini grandfather, Benito Cerini, founded the company in 1912 . With customers mainly based in Europe, FdT has various strategic alliances including BMW, Ferrari and Peugeot based on the production quality. While FdT is list on the Milan stock market the Cerini family continues to own 55% of the shares of the stock.

FdT’s traditional hurdle rate of return on capital is 14% and the historical company policy seeks payback of an investment within 5 years. FdT’s current liabilities are funded by 33% debt and 67% equity. The debt consists of loans from Banco Nazionale di Milano with an interest rate of 6.8%. Company’s effective tax rate is 43%.

Problem identification

FdT is facing an investment decision. The company can buy a Vulcan Mold-Maker machine for 1.01 million Euros which could replace six of current semi-automated machines. The new machine requires only 2 operators (1 per shift) as opposed to 6 current machines which require 24 workers (12 workers per shift) plus 3 maintenance workers. The new machine will also free about half of the space currently occupied by current machines.

Additionally , the Vulcan Mold-Maker Machines capacity is 30% bigger than the capacities of the current machines. It also produces products of better quality and lower scrape rates that the company is currently boasting.

Some considerations include that:

economic news from Europe suggests that there will be a slowdown and FdT may face reduced sales. While the FdT manufactures products for top of the line cars, sales would seem to be inelastic to economic slowdowns. Considering weather or not to expand during an economic slowdown should be kept in mind.

the company produces castings in a semi-automated process which is relatively labor intensive and requires training and some heavy lifting from workers. As a result the medical claims for injuries have doubled since 1998 as company’s products shifted towards heavy items.

The effect of inflation was briefly looked at in the analysis of the reduction of operating costs (results in section “Possible criticalities, conclusions and recommendations”).

Main hypotheses underlying the plan

The overall outlay for Vulcan Mold-Maker is estimated €1.01 million. This consists of:

initial purchase for the machine €850,000

€155,000 estimated changes to the plant, shipping, installation, and testing.

The cost of the Vulcan Mold-Maker could be offset by €130,000 as a result of selling the six old semi-automated stamping machines.

Value of the old machines = 415,000 – 130,692 = 284,318

Upon sale (€130,000), results in a capital (loss) = €130,000 – 284,318 = -€154,318

Capex = 1,010,000 – 130,000 – 0.43 x (154,318) = €813,643

Depreciation of the old machines is given as €47,520. Depreciation for the Vulcan Mold-Maker is 1,010,000/ 8 years = €126,250 pa.

A comparison of the costs differences shows a difference of €232,090 calculated below:

Old Machines

Vulcan Mold-Maker

Given Information:

Number of machines

6

1

Semi-Automated machines

415807.00

1010000.00

Cummulative depreciation

130682.00

0.00

Net Book

285125.00

1010000.00

Depreciation Average

47520.83

126250.00

Maturity

6

8

Useful Life

6

8

Depreciation p.a.

69300.33

126250.00

Re-sell offer for machines

130000

Calculation

Workers per shift

12

1

Shift

2

8

Hours per shift

8

2

Workings days in year

210

210

Hourly rate

7.33

11.36

Cost of workers

295545.60

38169.60

Maintaince workers per shift

3

 

Shift

1

 

Hours per shift

8

 

Workings days in year

210

 

Hourly rate

7.85

 

Cost of maintenance workers

39564

 

Cost of maintenance supplies

4000

59500

Electrical Power

12300

26850

 

 

-5200

Total cycle cost

€ 351,409.60

€ 119,319.60

Difference

€ 232,090.00

The Weighted Average Cost of Capital (WACC) for FdT is 9.86%.

This percentage was calculated by multiplying the cost of each capital by its weight and then adding the two.

The weight of debt was given as 33%. The cost of debt given was 6.8% (based on the interest rate of loans from from Banco Nazionale di Milano).

The weight of equity was given as 67%. The cost of equity used was 9.86%.

This number was calculated by multiplying the company’s beta of 1.25 by the equity risk premium of 6% and adding it to the risk free return of 5.3%. The beta, equity risk premium and risk free return were given in the case.

The corporate tax rate for FdT is 43%.

Cash flow differences are given by:

Cash Flow Difference

 

Semi-Automatic (Old Machines)

Vulcan Mold-Maker

Difference

Sales

S

 

S

 

Cost

C1

 

C2

 

€ 232,090.00

Deprec.

D1

 

D2

 

€ (78,730.00)

EBIT

(S-C1-D1)

€ 303,889.60

(S-C2-D2)

€ (6,930.40)

 

EBITDA

(S-C1-D1)*(1-T)

€ 173,217.07

(S-C2-D2)*(1-T)

€ (3,950.33)

 

Cash flow

(S-C1)*(1-T)+D1*T

 

(S-C2)(1-T)+D2*T

 

 

Cash Flow difference = (S-C1)*(1-T)+D1*T – [(S-C2)(1-T)+D2*T] = (C1-C2)x(1-T) + (D1-D2)x T = 232090 x (1-0.43) + 78730 x 0.43 = €166,145.20

Cash flow difference is greater than cost of capital of €80,225.20 (9.86% x 813,643)

Main conclusions/findings/insights

Given cash flow generated from investment in the Vulcan Mold-maker is greater than the overall cost of capital by €85,920 this would make the new machine a viable investment based purely on the financials. The SWOT and recommendations give a holistic review of the overall considerations.

Net Present Value with 3% inflation

Inflation

WACC

Net cash Flow

Present Value

1

9.86%

€ 166,145.20

€ 151,233.57

2

3%

10.16%

€ 166,145.20

€ 136,921.95

3

3%

10.46%

€ 166,145.20

€ 123,272.75

4

3%

10.77%

€ 166,145.20

€ 110,339.73

5

3%

11.10%

€ 166,145.20

€ 98,167.12

6

3%

11.43%

€ 166,145.20

€ 86,789.00

6

3%

11.77%

€ 252,500.00*

€ 129,488.63

Present Value

€ 836,213

* Resale value

Net Present Value of €836,213

Internal Rate of Return for the project is 9.42%.

SWOT analysis (if applicable)

Brief analysis on purchase of the new machine.

Strengths & Opportunities:

Solidifies customer contract opportunities mainly based on precision

Allows FdT to continue to develop precision casting/molding expertise

Can generate significant labour cost savings

Potential to result in reduced labour/medical claims

Lower waste/scrap rate resulting in more efficiency opportunities

Weaknesses/Opportunities

Large capital outlay

before potential economic slowdown

Unknown labour negotiations

What if/sensitivity analysis (key drivers identification)

This provides a cushion in the WACC of almost 3% for any changes in the cost of debt or the cost of equity that may cause the WACC to increase.

Any decrease in the WACC would prove the purchase of the new machine to be even more profitable.

Utilizing the WACC computed above, a review of the annual cash flows for the new project shows a positive net present value (NPV).

As a sensitivity, if an inflation rate of 5% were applied to the operating costs for the life of the new machine, the purchase of new machine would just be borderline favourable.

Criticalities and recommendations

Based on the NPV and IRR criteria, the company should proceed with the replacement of the semi-automated machines. Not only because of the positive NPV but also due to the other qualitative considerations such as the increased capacity, the additional floor space in the factory, the potential cost savings in administrative, medical, insurance, and training costs, and reduced waste.

The new machinery will imply higher quality of products which has proven to be a key factor in FdT negotiating longer-term contracts.

Another benefit is that FdT has the potential to down size it’s work force. This may require careful negotiations with the appropriate labour unions. Unfortunately based on the information provided, workers laid-off could only be re-deployed as janitors which would not likely be acceptable to both workers and unions.

A large part of the success of the purchase of the new machinery relies on the If cost savings are generated from work force reductions.

While a reduced work force would imply a decrease in medical claims and decreased insurance costs, if negotiations with the union are not positive (and combining this was a potential slowdown in Europe), then a viable recommendation could be to postpone the purchase of the new machine.