RWE Enterprises: Expansion Project Analysis
RWE Enterprises, Inc. (RWE) is a small manufacturing firm located in the hills just outside of Nashville, TN. The firm is engaged in the manufacture and sale of feed supplements used
by cattle raisers. The product has a molasses base but is supplemented with minerals and vitamins that are generally thought to be essential to the health and growth of beef cattle.
The final product is put in 125 pound or 200 pound tubs that are then made available for the cattle to lick as desired. The material in the tub becomes very hard, which limits the animals’
The firm has been running a single production line for the past five years and is considering the addition of a new line. The addition would expand the firm’s capacity by almost 120% since the newer equipment requires a shorter down time between batches. After each production run the boiler used to prepare the molasses for the addition of minerals and vitamins must be heated to 180 degrees Fahrenheit and then must be cooled down before beginning the next batch. The total production run entails about 4 hours and the cool down period is 2 hours (during which time the whole process comes to a halt). Using two production lines increases the overall efficiency of the operation since workers from the line that is cooling down can be moved
to the other line to support the “canning” process involved in filling the feed tubs.
The second production line equipment will cost $3 million to purchase and install and will have an estimated life of 10 years at which time it can be sold for an estimated after tax scrap value of $200,000. Furthermore, at the end of five years the production line will have to be refurbished at an estimated cost of $2 million.
RWE’s management estimates that the new production line will add $700,000 per year in after
tax cash flow to the firm such that the full 10 year cash flows for the line are as follows:
Year After-tax Cash Flow
a. If RWE uses a 10% discount rate to evaluate investments of this type, what is the net present value of the project? What does this NPV indicate about the potential value RWE might create by purchasing the new production line?
b. Calculate the internal rate of return and profitability index for the proposed investment. What do these two measures tell you about the project’s viability?
c. Calculate the payback and discounted payback for the proposed investment. Interpret your findings.