Case Study: Shrieves Casting Company

Introduction
In this case study, Shrieves Casting Company carried out a capital budgeting analysis on a project to add a new production line. In the report, key concepts of sunk cost, opportunity cost, and cannibalization are discussed in relation to whether they should be included in the calculation of incremental cash flow. Also, the net cash flow of the new project is produced, together with the project evaluation measures such as NPV, IRR, and MIRR. In addition, the concept is risk is discussed, and sensitivity analysis as well as scenario analysis are performed to access the impact on NPV under different conditions. Based on the outcome of these analysis, a decision is made as to whether the new project should be accepted.
Analysis
Background

Now assume the plant space could be leased out to another firm at $25,000 per year. Should this be included in the analysis? If so, how?
The alternate use of the site is to lease for $25,000 per year. This represent an opportunity cost for the use of the site, and affects the incremental cash flow for the new project. Therefore this opportunity cost must be charged to the new project, failing which the caluculated NPV would be overstated (Brigham & Ehrhardt, 2014).
Part a4. Finally, assume that the new product line is expected to decrease sales of the firm’s other lines by $50,000 per year. Should this be considered in the analysis? If so, how?
The new project’s incremental cash flow from the incremental sale must be reduced by the cash flow lost of $50,000 by its other lines. This cannibalization is an example of externalites which are the effects a project has on other parts of the firm or the environment (Brigham & Ehrhardt, 2014). This lost in cash flow must be charged as a cost when analyzing the new project.
Solution
Part b. Disregard the assumptions in part a. What is Shrieve’s depreciable basis? What are the annual depreciation expenses?
The yearly depreciation rate for a MACRS 3-year class is 33.33% for year 1, 44.45% for year 2, 14.81% for year 3, and 7.41% for year 4 (“MACRS,”

Calculate the annual sales revenues and costs (other than depreciation). Why is it important to include inflation when estimateing cash flow?
Incremental revenue. The new line would generate incremental sales of 1,250 units per year for 4 years at $200 per unit in the first year, with price increasing by 3% per year. The annual sales revenue would be 1,250 x $200 = $250,000 in year 1. At 3% increase per year, the annual sales revenue would be $200 x 1.03 x 1,250 = $257,500.00 for year 2. The revenue would be increased at 3% per year to $265,225.00 and $273,181.75 for year 3 and 4 respectively.
Incremental cost. The incremental cost per unit is $100 in the first year, excluding depreciation, increasing at 3% per year. The incremental cost would be 1,250 x $100 = $125,000 in year 1. At 3% increase per year, the cost would be $100 x 1.03 x 1,250 = $128,750.00 for year 2. The cost would be increased at 3% per year to $132,612.50 and $136,590.88 for year 3 and 4 respectively.
Inflation. It is important to include inflation when estimating cash flow to reflect the true NPV. Otherwise the estimated NPV would be lower than the true NPV, which could cause a company to reject a project that it should have accepted (Brigham & Ehrhardt,