Mondi Plastics Company is one of the small companies that have got into a contract agreement with Ford Motor Co. to produce spoilers for their new 2013 Ford Fusion. They have an option of using their current plant which is almost at peak capacity. This option will require an initial cost $400,000 for the mold and will generate annual cash flows of $300,000. If they exercise this option, they cannot take additional work from Ford or any other company. They also have the alternative of opening a new plant which will cost them $800,000. With the new plant there is a 25% chance that they will generate cash flow of $300,000/yr. If this happens, they will sell the plant at $600,000 after year 1. With the new plant, there is also a 75% chance of increased production with a cash flow of $450,000 in that first year. If this is the case, they will either: • Expand New Plant which will require $250,000 investment. This is projected to generate annual cash flows with respective probabilities as follows: $750,000 (0.2), $450,000 (0.5), and $550,000 (0.3). OR • No expansion: in which case the current production and CF of $450,000/yr will be maintained for the remaining years. Given a MARR of 12% and a 3 year study period, use excel and: a) Construct a decision tree and include all the values and probabilities. b) Determine the expected PW values for the "Expand New Plant/No Expansion" decision node which occurs after year 1. c) Determine the expected PW values for the "Current Plant/New Plant" decision node and give your recommendation on what option the management of Moindi should take.
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
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