Finance and Accounting

CASE STUDY
Bentley Custom Ceramics
Please read the handout Case 10: Bentley Custom Ceramics before starting this assignment.

Assume you have been asked to analyse the decision faced by Julian Bentley with additional information given below.

1) Mr Reynolds informed Julian that his loan application to purchase either type of kiln including installation and expert testing has been approved. The terms of the loan would be payment of yearly interest in advance at a fixed rate of 12% per annum over the life of the project and repayment of the principal owing at maturity.

2) The estimated service life for a gas-fired kiln is 10 years and six years for an electric kiln. The salvage values for a gas-fired kiln and an electric kiln at the end of their usable lives are $4,000 and zero , respectively. Julian’s accountant allocated depreciation to the gas-fired kiln in the modified accelerated cost recovery (MACRS) 10-year class and the electric kiln could be depreciated using the MACRS category for 5-year assets. Depreciation allowance percentages according to MACRS are shown in the table below.

MACRS Allowance Percentages
Year 5-year assets 10-year assets
1 20% 10%
2 32% 18%
3 19% 14%
4 12% 12%
5 11% 9%
6 6% 7%
7 7%
8 7%
9 7%
10 6%
11 3%

3) As you were checking the sales and cost projections for the new kilns provided by Julian in Exhibit 4, you noted that he had not made a provision for the increased working capital requirements with the new equipment. This would entail an initial increase in accounts receivable of $10,000, an increase in accounts payable of $15,000, and an increase in inventory of $25,000. Net working capital requirements for subsequent years will be 10% of additional sales.

4) You had learnt in your postgraduate finance course that project cash flows typically have different levels of risk. You had a discussion with Julian to get a feel for the uncertainties involved the cash flow estimates. Julian concluded that there was little uncertainty in any of the estimates except for the sales projection, which could vary significantly depending on the market demand. In his opinion, the sales projection could deviate from the estimated figure given in Exhibit 4 by plus or minus 20%.

5) Under the current rental agreement, Julian has an option to extend the lease for another 10 years at a higher rental payment of $10,000 per year.

6) Assume the company tax rate is 30% per annum and the acceptable payback period is 3 years.
Your task is to prepare the capital budgeting report for Julian Bentley advising whether he should invest in the new equipment in January 2000. Your report should include the answers to the following Questions 1 to 7. It is important to list your assumptions in applying the capital budgeting techniques, and show clearly the workings in deriving your results. Your assignment will be graded based on presentation, understanding of the issues and logical explanation, and accuracy of calculations in solving the problems. The mark allocations for individual questions (including 20 marks for presentation) will total 125 marks and will be scaled by a factor of 0.2 to produce a mark consistent with 25% weighting in the unit assessment.
QUESTIONS

5. Draw the ANPV and NPV profiles for both the electric and gas-fired kilns on the same set of axes (by varying the discount rates from 0%, 10%, 20%, 30%) and discuss any conflict in ranking that may exist between NPV and ANPV.
[12 marks]

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