​​​ Please read the handout Case 10: Bentley Custom Ceramics before starting this assignment. AssumeyouhavebeenaskedtoanalysethedecisionfacedbyJulianBentleywithadditional information given below. 1) MrReynoldsinformedJulianthathisloanapplicationtopurchaseeithertypeofkiln includinginstallationandexperttesting has been approved. Thetermsof theloanwould bepaymentofyearlyinterestinadvanceatafixedrateof12%perannumoverthelifeof the project and repayment of the principal owing at maturity. 2) The estimated service life for a gas-fired kilnis 10 years andsix years for an electric kiln. Thesalvagevaluesforagas-firedkilnandanelectrickilnattheendof theirusablelives are $1,000 and zero2, respectively.Julian'saccountantallocateddepreciationtothegas- firedkilnusingthemodifiedacceleratedcostrecovery(MACRS)fora10-yearasset class and the electric kiln using the reducingbalancemethodat40%perannum. Depreciation allowance percentages accordingtoMACRS are shown in the table below. MACRS Allowance Percentages Year 10-year assets 1 13% 2 18% 3 14% 4 12% 5 7% 6 7% 7 7% 8 7% 9 7% 10 5% 11 3% 3) AsyouwerecheckingthesalesandcostprojectionsforthenewkilnsprovidedbyJulian inExhibit4,younotedthathehadnotmadeaprovisionfortheincreasedworking capitalrequirementswiththenewequipment.Thiswouldentailaninitialincrease in accountsreceivableof$10,000,an increasein accountspayableof$15,000,and an increaseininventoryof$25,000.Networking capitalrequirementsforsubsequentyears will be 10% ofadditional sales. 4) Youhadlearntinyourpostgraduatefinancecoursethatprojectcashflowstypicallyhave differentlevelsofrisk.YouhadadiscussionwithJuliantogetafeelfortheuncertainties 1 ThiscasestudywasadaptedfromCase10:"BentleyCustomCeramics"byStretcher,R.&Michael,T.B. (2005), Cases inFinancial Management,New Jersey: Pearson Education, Inc. 2The scrap value will be exactly offsetby removal costs. involvedthecashflow estimates.Julianconcluded that there was little uncertainty in any of the estimates except for the sales projection, which could vary significantly depending onthemarketdemand.Inhisopinion,the salesprojectioncoulddeviatefromthe estimated figure given in Exhibit 4 by plus or minus 20%. 5) Underthecurrentrentalagreement,Julianhasanoptiontoextendtheleaseforanother 10 years at a higher rental payment of $10,000 per year. 6) Assumethecompanytaxrateis30%perannumandtheacceptablepaybackperiodis3 years. Your task is to prepare the capital budgeting report for Julian Bentley advising whether he should invest in the new equipment. 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 accuracyofcalculationsinsolvingtheproblems. Themarkallocationsforindividualquestions (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% weightingin the unit assessment. QUESTIONS 1. Based on the information given in the case, prepare two cash flow tables (which incorporatetaxesandincludeinitialinvestment,operatingandterminalcashflows)for thepurchaseof3gas-firedkilnsand12electrickilns.Decideifeachofthefollowing items should be included in the cashflow table. Explain your decision. a) The increase in accountsreceivable,accountspayableandinventory; b) The termloan and the yearlyinterestexpense; c) The increase in rental payment after seven years; d) The estimates of higher utilities expense. Explain clearly your assumptions in deriving the figures in your cash flow. [37marks] 2. Whataretheimplicationsofmutuallyexclusiveprojects;wouldyoucharacterisethe electric and gas-fired kilns as mutually exclusive; why or why not? [4marks] 3. What is the appropriate cost of capital to use for discounting expected future cash flows? [4marks] 4. Based on the cash flows from Question 1 and any additional calculations required necessary, would you recommend Julian to purchase the gas-fired kilns or the electric kilnsbasedon(i)thepaybackperiod(PP),(ii) netpresentvalue(NPV)and(iii)internal rate of return (IRR) methods?[Assume the after-tax cost of capital is 15% for the NPV method.] [15marks] 5. DrawtheANPVandNPVprofilesforboththeelectricandgas-firedkilnsonthesame setofaxes(byvaryingthediscountratesfrom 0%,10%,20%,30%)anddiscussany conflict in ranking that may exist between NPV and ANPV. [12marks] 6. Giventheriskinherentinanyproject,itiscrucialthatyouperformprojectriskanalyses on the new investment's NPV and IRR before making any recommendation. For either type of kiln a) Calculatetheminimumlevelofadditionalannualsalesnecessaryforeachproject to be acceptable. b) Doascenarioanalysis(i.e.pessimisticestimates)ofNPVsandANPVstochanges insalesprojectionandcostofcapital.Assumesalescandeviatefrom theestimated value by minus 20% and the after-tax cost ofcapital is 3-percentage points higher. c) If the expected rate of inflation is 3%per year, what would be its effect on the NPV and ANPV?Discuss the impact and direction of change, not precise figures. d) BasedonthelastIncomeStatementforBentleyCustomCeramics,whatisJulian's marginaltaxrate?DonotrepeatthecalculationsinQuestion1togetanew solution, butdetermine(i)whatitemswould be changed; and (ii)whetherthe IRR and NPV would be raised or lower by the shift intax rate. [25marks] 7. MakearecommendationastowhetherornotJulianshouldpurchasethekilns.Explain allfactorsthatwouldaffectthedecisioninyourrecommendation,includingtheanalysis of the project risk (Question 6).