Magic Timber & Steel Investment Evaluation with Net Present Value Case Solution
In next step, we changed some criteria for carrying out the sensitivity analysis, for which we changed the interest rate from 11% to 10%, tax rate from 30% to 25%, sales proceed at the end of fifth year for Delta from 60,000 to 100,000, annual interest payment on principal amount from 6% to 5% and the Delta fixed maintenance rate at the first year of purchase from 2000 to 1000.
| Cash Flows: | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| Immediate sale of Matrix | 35,000 | |||||
| Scrap forgone | (5,000) | |||||
| Repair and Maintenance (Matrix) | 28,000 | 7,000 | 7,000 | 11,000 | 7,000 | 7,000 |
| Immediate Purchase of Delta | (140,000) | |||||
| Repair and Maintenance (Delta) | (1,000) | (2,000) | (3,000) | (4,000) | (5,000) | |
| 5% interest rate | (7,000) | (7,000) | (7,000) | (7,000) | (7,000) | |
| Savings in labor cost | 5,250 | 5,500 | 5,750 | 6,000 | 6,250 | |
| Savings in electricity cost | 4,725 | 4,800 | 4,875 | 4,950 | 5,025 | |
| Sales Proceeds of Delta | 100,000 | |||||
| Net Savings and (Payments) of Tax | (7,000) | (244) | (75) | (906) | 263 | (7,069) |
| Total Cash Flows | (84,000) | 8,731 | 8,225 | 10,719 | 7,213 | 94,206 |
| Discount Factor | 1 | 0.9091 | 0.8264 | 0.7513 | 0.6830 | 0.6209 |
| Discounted Cash Flows | (84,000) | 7,938 | 6,798 | 8,053 | 4,926 | 58,495 |
| Net Present Value (NPV) | 2,209 |
The +2,209 NPV indicates that after performing the sensitivity analysis, we found an attractive view of the company with positive NPV.
Evaluations of Alternatives:
We have two alternatives with four main problems.
Alternate 1 is to repair the old machine (Matrix).
Alternate 2 is to replace the old machine (Matrix) with the new machine (Delta).
We have ratings 1 to 5 for all the problems where 1 represents the little solution for that problem and 5 represents the complete solution of that problem.
Decision Criteria
| Problems | Alternative-1: Repair Matrix | Alternative-2: Replace Matrix with Delta |
| Decrease in Production Cost | 1 | 3.5 |
| Obsolesce of production machine | 5 | 2 |
| Increase in Profit Margins | 2 | 4 |
| Total | 8 | 9.5 |
Recommendation:
After analyzing the both alternatives by assigning the ratings according to the decision criteria matrix, we found out that the alternate 2 is suitable for Magic Timber and Steel to go forward with because alternative two provides the almost complete solution of all the main problems faced by the company. Although alternative two provides a negative NPV but it also provides the complete solution of all the four major problems in Magic Timber and Steel. Negative NPV does not include the production estimations that will be obtained from new machine or the estimations of future sales and so on. It just includes the replacement cost for timber production with advanced technology and low cost of production..........
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