Fonderia di torino case study group1_2016
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Transcript of Fonderia di torino case study group1_2016
Fonderia di Torino S.p.ACapital Budgeting
Group 1:Abhishek Sharma
Cynthia Hanna Mingjie Bai
Wilfred Kennedy Aldowine
Nov 7, 2016
Fonderia di Torino: Current Situation
Current Situation: With its strong partnerships in the Automotive industry and its reputation for quality products, Fonderia di Torino is one of the top companies in Italy specialised in the production of precision metal castings used in several industries
Challenge: How can Fonderia di Torino reduce cost, improve production quality and reduce rejection rate of its parts by OEMs?
To purchase a new fully automated molding machine operated with only two skilled operators providing 30% more floor space with higher levels of production quality
Investment Required: € 1,01 million
Current Capital Investment Options
Vulcan Mold-Maker Machine
Is the investment profitable or not?
What is the actual initial outlay of the new machine?
New Machine Capital Expenditure = € 813,296.25
Total investment of new machine is €1.01million, but with the Capital Loss from the Sale of the old machines deducted from the overall asset acquisition cost, the initial outlay will be much less
* Estimated Resale Value of the old machines = €130K
How to finance the new machine? What is your cost of capital?
Weighted Average Cost of Capital - WACC = 9.86%
Compared with the hurdle rate of 14%, WACC provides a very competitive rate for financing the investment as it is lower than the average prevailing cost of capital in the market
Debt Ratio
Equity Ratio
MARKET VALUE OF COMPANY'S CAPITAL
Interest Rate = 6.80%
*Cost of Equity = 12.80%
33%67%
* Cost of Equity calculated based on a 5.3% Risk-free Return, Company’s Beta 1.25 and Equity Risk Premium of 6%
Let’s compare Operating Cost per year of the existing machines VS. the new machine
€ -
€ 50,000.00
€ 100,000.00
€ 150,000.00
€ 200,000.00
€ 250,000.00
€ 300,000.00
€ 350,000.00
Labor Cost MaintenanceLabor Cost
MaintenanceSupplies
ElectricalPower
Side EffectsAdditional
Positive
Old Machines New Machine
On old machines, the biggest allocation of the Operating cost is Labor Cost
On new machine, the biggest allocation of the Operating cost will be on Maintenance supplies
Total Operating Cost Comparison
Total Operating cost of old machines is 3x morethan cost of the new machine
€ 351,409.60
€ 119,319.60
€ -
€ 50,000.00
€ 100,000.00
€ 150,000.00
€ 200,000.00
€ 250,000.00
€ 300,000.00
€ 350,000.00
€ 400,000.00
Old Machines New Machine
∆ Operating Cost Delta
€ 232,090
Incremental Future Cash Flows that will be generated from new machine
As per the NPV method of capital investment, projects with positive NPVs are profitable
With this investment, you will be making a profit of approx. €23K
Depreciation Year 7+8
€ 252,500
Initial Cost
€ 813,296.25
1 2
166,145 166,145 166,145 166,145 166,145 166,145
3 64 5
PV of discounted Cash Flows
€ 836,212.75
* The above calculations are based on a Cost of capital with inflation rate of 3% YOY
Net Present Value NPV > 0
€ 22,916.50
The investment is profitable from an financial perspective
But let’s look at some other implications
What about the lay-off cost of the workers that have are working on the old machines?
* Savings from new machine calculated based on the difference between incremental cash flows per year and cost of capital per year and an inflation rate of 3% YOY
As per the Italian labor law, employees are to be paid a 6 months compensation to be laid off
In your case, even if you decide to pay a total of 1 year salaries, you would still be making a profit from the new machine
Economy Outlook for the coming years…
Current Expected Inflation is 3% Year on Year
But the economy looks like it’s heading to a slow-down – which is a concern
Based on a sensitivity analysis and simulations for your capital investment, your inflation threshold to keep a positive NPV is 5% YOY
With a 5% Inflation rate, your weighted average cost of capital would reach a maximum of 13.21% which would still be lower than the current hurdle rate of 14%
Even if the economy slows down more than expected, you would still be profiting from the new investment as you have a 2% margin / safety cushion from the increasing inflation rates pushing higher your cost of capital
Non-Financial implications reinforcing your decision to go ahead with the new machine acquisition
The extend of which the new machine will improve your quality of production
Reducing Operational cost
Reducing Labor Costs by 90% and minimising any potential lawsuits that might arise between the company and Labor Unions
Reducing scrap rate / rejection rate
Saving space in the factory up to 30% which could be used for storage or other new assets
Maintaining your reputation as a market leader in new technology and leading the way in the progress in the industry
Appendix: Details of the Calculations in the Excel file including all sensitivity analysis with different scenarios
Thank You