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Finance Case Study Solution

The document discusses a case study regarding a company called Fonderia di Torino S.p.A considering purchasing an automated molding machine called the Vulcan Mold-Maker to replace its old semi-automated machines. It assesses the economic benefits of the investment by calculating the net present value (NPV) under different sales scenarios and discount rates. The NPV is positive if annual sales are between €328,338 and €434,036, indicating the new machine investment is warranted. Even with zero sales, the new machine provides higher economic value added over continuing with the old machines. The investment in the new automated equipment will benefit the company over time by replacing labor-intensive processes with greater automation.

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Omar Mosalam
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201 views4 pages

Finance Case Study Solution

The document discusses a case study regarding a company called Fonderia di Torino S.p.A considering purchasing an automated molding machine called the Vulcan Mold-Maker to replace its old semi-automated machines. It assesses the economic benefits of the investment by calculating the net present value (NPV) under different sales scenarios and discount rates. The NPV is positive if annual sales are between €328,338 and €434,036, indicating the new machine investment is warranted. Even with zero sales, the new machine provides higher economic value added over continuing with the old machines. The investment in the new automated equipment will benefit the company over time by replacing labor-intensive processes with greater automation.

Uploaded by

Omar Mosalam
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Finance Case Study: Fonderia di Torino S.p.A.

Case Overview:
Company considering purchase of Vulcan Mold-Maker automated
molding machine. Machine prepares sand molds into molten iron
using iron castings, automates manual intensive process.

Questions:

1.Assess the economic benefits of acquiring the Vulcan Mold-Maker


machine. What is the initial outlay? What are the benefits over time?
What is an appropriate discount rate? Does the net present value
(NPV) warrant the investment in the machine? Assume that with
ordinary maintenance, the semi-automated equipment could be
operated for two more years beyond its depreciable life.

Given:

Total Cost New Machine = 1,010, 000 EurosDepreciated over 8 yrs;


replace after 8yrs. Offer for (6) Old Machines = 130,000 E eachAfter-
Tax Market Value for Old Machine. Original Cost of Old Machines =
415, 807 ECumulative Depreciation = 130,682 E Tax Rate of
Company (t) = 43%

Initial Case Outlay:

Price of New Machine = -1,010,000


Current After-Tax Market Value of Old Machine =
[130,000+(415,807-130,682)-130,000*0.43] = 196,704
Net outlay for new machine:
-1,010,000+196,704 = -813,296 Euros

Given:

Beta Coeffecient (B) = 1.25Market Value of Company’s Capital = 33%


Debt Assumed Equity Risk Premium = 6%Market Value of Company’s
Capital = 67% Equity Risk Free Rate of Return (Rf)= 5.3%
Before Tax Cost of Debt (Rd) = 6.8%

Appropriate Discount Rate:

Using CAPM:
Rs = Rf+B(Rm-Rf)
Rs =5.3%+1.25*6%
Rs =12.8%

After-Tax Cost of Debt = Rd (1- t):


Rb = 6.8%*(1-0.43)
Rb = 3.88%

Compute WACC:
R(wacc) = (%Debt)*(Rb)+(%Eqty)*(Rs)
R(wacc) = (33%)*(3.88%)+(67%)*(12.8%)
R(wacc) = 9.86%

Net Present Value:

Since we are not provided with the information or evidence about cash
inflow needed to calculate the Net Present Value, we assumed three
different scenarios to cover all possible outcomes.

Replace with New(automated) Machine

Initial Cash Outlay(813,296)


Operating Cash Flow
(OCF)Sales-(2*2*11.36*8*210+59,500+26,850-5,200)*
(1-0.43)+(1,010,000/8*0.43)
NPV_new-813,296+OCF_new*PVIFA(9.86%,8years)

*NPV_new equation tells us that when sales is 328,338.07, NPV is


zero. 328,338.07 is our "magic number" to find out the NPV of
replacing the old machine with the new one.

If Sales > 328,338.07 then NPV>0


If Sales < 328,338.07 then NPV 434,036.67 then NPV>0
If Sales < 434,036.67 then NPV 434036.67
NPV of New-++
NPV of Old--+
By looking at the above diagram we can conclude that when sales is
between 328,338.07 and 434,036.67, Fonderia di Torino S.p.A should
definitely replace the old machine with the new automated machine.

However, in the other two scenarios, we have to take one more factor
into consideration which is the EAA assuming that sales are equal for
both cases, in order to make the decision whether to invest in the new
machine or not.

*For the sake of simplicity we put sales as zero


Replace with New(automated) Machine

Initial Cash Outlay(813,296)


OCF0-(2*2*11.36*8*210+59,500+26,850-5,200)*
(1-0.43)+(1,010,000/8*0.43)=-35,481.34
Raw NPV(1,003,555)
EAA(187,153)

Keep Old(semi-automated) Machine

Opportunity cost(196,704)
OCF0-(24*7.33*8*210+2*3*7.85*8*210+4000+12300)*
(1-0.43)+(47,520*0.43)=-265,520.35
Raw NPV(1,357,874)
EAA(310,500)

Keep using the old machine incurs higher cost (higher EAA) than
replacing it with the new one. Therefore assuming sales are equal for
both cases, when sales is smaller than 328338.07 and greater than
434036.67, Fonderia di Torino S.p.A should definitely replace the old
machine with the new automated machine.

Benefit over time.


The three scenarios illustrated above clearly shows that the
investment in the new machine creates greater value to the company,
unless there should be some unexpected turnout in sales. By
acquiring the Vulcan Mold-Maker machine Fonderia di Torino S.p.A
will be able to replace labor intensive required semi-automated
machines with...

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