Professional Documents
Culture Documents
Fonderia Torino
Fonderia Torino
1. Please assess the economic benefits of acquiring the Vulcan Mold-Maker machine. What is the initial outlay? What are
the benefits over time? What is an appropriate discount rate? Does the net present value(NPV) warrant the investment in the
machine?
Rs = Rf+B(Rm-Rf)
=5.3%+1.25*6%
=12.8%
Rb = 6.8%*(1-0.43)
= 3.88%
R(wacc) = (33%)*(3.88%)+(67%)*(12.8%)
= 9.86%
Since we are not provided with the information or evidence about cash inflow needed to calculate the Net Present Value, we
assumed three different scenarios to cover all possible outcomes.
*NPV_new equation tells us that when sales is 328,338.07, NPV is zero. 328,338.07 is our "magic number" to find out the
NPV of replacing the old machine with the new one.
Opportunity cost(196,704)
Operating Cash Flow
(OCF)Sales-(24*7.33*8*210+2*3*7.85*8*210+4,000+12,300)*
(1-0.43)+(47,520*0.43)
NPV_old-196,704+OCF_old*PVIFA(9.86%,6years)
*NPV_new equation tells us that when sales is 435,036.67, NPV is zero. 435,036.67 is our "magic number" to find out the
NPV of keep using the old machine.
However, in the other two scenarios, we have to take one more factor into consideration which is the EAA assuming that
sales are equal for both cases, in order to make the decision whether to invest in the new machine or not.
Opportunity cost(196,704)
OCF0-(24*7.33*8*210+2*3*7.85*8*210+4000+12300)*
(1-0.43)+(47,520*0.43)=-265,520.35
Raw NPV(1,357,874)
EAA(310,500)
Keep using the old machine incurs higher cost(higher EAA) than replacing it with the new one. Therefore assuming sales
are equal for both cases, when sales is smaller than 328338.07 and greater than 434036.67, Fonderia di Torino S.p.A should
definitely replace the old machine with the new automated machine.
2.What uncertainties or qualitative considerations might influence our 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.
NPV and EAA proved that the company should invest in the new machine. However, there are still some uncertainties that
might affect the attractiveness of the new machine. Federia Torino S.p.A still has to decide whether the tough collective-
bargaining agreement the company has with the employees' union would allow the company to lay off the 24 operators of
the semi-automated machines. Reassigning the workers to other jobs might be easier, but the only positions needing to be
filled are those of janitors, who are paid 4.13 euros an hour. The extent of any labor savings would depend on negotiations
with the union. If the workers are reassigned as janitors, NPV will decrease due to increase in labor costs.
Secondly, the company is still unsure when added capacity of the new machine would be needed. The old machines
currently operate at only 90 percent of capacity. The projection as to how much capacity of the new machine will be
utilized, will have a considerable influence on the outcome of the NPV.
Lastly, the latest economic news suggests that the economies of Europe are headed for a slowdown which will also have a
strong impact on the outcome of the NPV.
How about the inflation rate of 3 percent (or higher)? Will that affect the attractiveness of the Vulcan Mold-Maker? The
answer is no. Inflation rate does not affect NPV since NPV is always calculated using real rate or nominal rate
"consistently."