Rockafeller Music Company

Integrative Capital Budgeting Problem

Created by Pamela Peterson Drake

The Rockafeller Music Company is considering expanding its production line to satisfy the demand for more CDs. The company has commissioned consultant studies for the expansion, spending $200,000 for these studies. The results of the studies indicate that the firm must spend $1 million on a new building and $500,000 on production equipment. The consultants' report predicts that the company can increase its revenues by $400,000 each year, while incurring an increase of $160,000 in expenses. The consultants expect rivals to step up production within five years, reducing benefits from the expansion to Rockafeller after five years. Therefore, a five-year time horizon is assumed for this expansion project. The expansion would require that the company increase it currents assets by $100,000 initially, but these asset accounts will be returned to previous levels at the end of the project.

Assume that the building is depreciated using straight-line over a twenty-year period and that it can be sold at the end of five years for $800,000. Further assume that the equipment is depreciated using straight-line over a ten-year period and that it can be sold at the end of five years for $150,000. The marginal tax rate of Rockafeller is 40%. The cost of capital for this project is 10%.

Should Rockafeller invest in this project? Explain.


Work Sheet

 
Year
Item012345
Buy and sell the building      
Buy and sell the equipment      
Tax on the sale of the building      
Tax on the sale of the equipment      
Change in working capital      
Acquisition and disposiiton cash flows      
Change in revenues      
Change in expenses      
Change in depreciation      
Change in taxable income      
Change in taxes      
Change in income after taxes      
Add: Change in depreciation      
Change in operating cash flow      
Change in net cash flow      
Net present value =

Internal rate of return =

Solutions