Die casting is a manufacturing process for producing accurately dimensioned, sharply defined, smooth or textured-surface metal parts. These parts run the gamut from boat propellers to gear assemblies. Generations ago the products were almost exclusively steel. More recently aluminum and zinc alloys have been used. Shrieves Casting Co. has been in the business of die casting for 40 years. Since its inception it has specialized in producing aluminum products, but now is considering adding zinc alloy die casting to its product offerings. The Vice President for Finance, Sidney Johnson, has asked you to take the first crack at estimating the cash flows associated with the project.


The zinc alloy products would be manufactured on a new production line in an unused space in Shrieves’ main plant. The space was in a dilapidated part of the plant; however Shrieves spent $100,000 rehabilitating the area so it could be used for some productive purpose.

This is the question that I want to ask: In fact, Thomas Shrieves Jr. son of the company owner, is hopeful he might be allowed to lease the space for $25,000 per year as a production location for his own separate small business. This is a capital budgeting question and this is the opportunity cost, where should the opportunity cost be recorded in the spread sheet of capital budgeting since it is $25,000 per year and they year of the project is for 4 year. Should we present value the total 4 year and put it in the initial investment and add it back in the terminal value at the end of the project or where should I record this opportunity cost? The tax is 40%. Thanks

You should figure the present value of it for 4 years, yes, after you subtract the tax since it's lease income and subject to it. (Always think about what they are actually going to get out of something.)
But that's not part of initial investment. The investment is an outlay of cash, not income. And something coming in over the next four years isn't an investment. The investment is always going to be initial costs initially spent, in a lump sum(s). You're always comparing those initial costs to what is going to happen into the future from making the investment.
However, I can't say anything more specific because there seems to be some missing information and I don't see exactly what's going on here. In fact, I'm not even sure if what I said applies exactly to this problem, but that's at least the general concept.

Die casting is a manufacturing process for producing accurately dimensioned, sharply defined, smooth or textured-surface metal parts. These parts run the gamut from boat propellers to gear assemblies. Generations ago the products were almost exclusively steel. More recently aluminum and zinc alloys have been used. Shrieves Casting Co. has been in the business of die casting for 40 years. Since its inception it has specialized in producing aluminum products, but now is considering adding zinc alloy die casting to its product offerings. The Vice President for Finance, Sidney Johnson, has asked you to take the first crack at estimating the cash flows associated with the project.

The zinc alloy products would be manufactured on a new production line in an unused space in Shrieves’ main plant. The space was in a dilapidated part of the plant; however Shrieves spent $100,000 rehabilitating the area so it could be used for some productive purpose. In fact, Thomas Shrieves Jr. son of the company owner, is hopeful he might be allowed to lease the space for $25,000 per year as a production location for his own separate small business.

The machinery’s invoice price would be approximately $200,000, another $10,000 in shipping charges would be required, and it would cost an additional $30,000 to install the equipment. The machinery has an economic life of 4 years, and Shrieves has obtained a special tax ruling that places the equipment in the MACRS 3-year class. Shrieves expects to be able to sell the machinery to a friendly competitor for $25,000 after the 4th year.

The new line would generate incremental sales of 1250 units per year for 4 years at an incremental cost of $100 per unit in the first year, excluding depreciation. Each unit is expected to sell at a price of $200 in the first year. The sales price is expected to increase by 4% per year and the unit cost is forecast to grow at 3%, due to inflation. Moreover, with the increase in production net working capital is anticipated to increase each year. It is forecasted to be 12% of sales revenues. Shrieves’ marginal tax rate has been consistently near 40% and is expected to remain so. Sidney has suggested that in your initial analysis, you assume a 10% WACC.

Sidney is uncertain about some of the assumptions that are being used in the analysis. Therefore, she has asked that in addition to an NPV, IRR ?

There is an attachment of my spread sheet. Thank you for your help..

Now that I've seen the whole thing, I can tell you I can't help with all of it. There's crossover with financial accounting, cost accounting and finance. Finance is used more for cost, and this is getting in too deep for me. (For instance, I don't do IRR and MIRR at all.) There's also some stuff I'm not quite sure why it's being done that way, cause it isn't the way most of what I see would be done. I'll just comment on what I can comment on - better than nothing, or maybe someone will know the rest.

Depreciation stuff is fine. Good catch on the tax on the salvage - I didn't catch it. :-) The whole section with sales, etc is fine, except you've got some rounding issues going on there.

Just as a note, you really need to learn how to do an absolute cell reference. Like row 45 - every one is multiplied by (1 + C11). Highlight over the C11 and hit F4. That'll make it look like $C$11, which makes it absolute. Then you can copy right and it'll stay C11, instead of moving relative to C12, C13, etc. This works great for items from an input section so you don't have to keep re-doing it in every cell. You also could skip the row with the 1250. The whole point of an input section is not repeating it elsewhere like this. Then take the sales price * C5, make the C5 absolute, and just copy to the right.

Anyway... Based on the numbers you have at the bottom line, the NPV is correct. However...

I can't say as I get the working capital section. I'm sure I did that in some class umpteen years ago, but the ones I've worked on with students since then have had a one-time working capital requirement, and this is different. So can't tell you.

As for the lease, I have a bit of an issue with this, but I've had this disagreement before. Looks like you're assuming the entire lease payments comes in at the beginning of the year, making it year 0. But does the tax match that? I also don't get why you're adding the 60,000 as a recovery of the lost lease. I see how you gain back working capital, but not how you gain back a lost lease opportunity.

Thank you for your help. Really appreciate it, it somehow help me finish the case. Thanks aloooott! :)

You're welcome. :-)