# sugar bowl case study analysis

Question/Answer On Project Management Submitted By: Date: Problem: Construct a cash flow diagram for each option Solution The given information consists of the following items. Item Machine A Machine B Initial Cost $10,000 $15,000 Projected Annual Profit $1,800 $3,000 Year-5 Overhaul Cost $0 $5,000 Salvage Value $2,000 $4,000 Life of Project (years) 10 10 The cash flow diagram can be made by projecting the inflows and outflows of cash flow in time. The net cash flow can be calculated by subtracting the cash outflows from cash inflows. The following table shows the net cash flow for each time period. Machine A Period (years) Profit ($) Costs ($) Net cash flow ($) 0 - 10,000 (10,000) 1 1,800 - 1,800 2 1,800 - 1,800 3 1,800 - 1,800 4 1,800 - 1,800 5 1,800 0 1,800 6 1,800 - 1,800 7 1,800 - 1,800 8 1,800 - 1,800 9 1,800 - 1,800 10 1,800 - 1,800 Net Cash flow Diagram 1,800 1,800 1,8001,8001,8001,8001,8001,8001,800 1,800 0 1 2 3 4 5 6 7 8 9 10 (10,000) Cash Flow Projection for Machine B is given below with the net cash flows. Machine B Period (years) Profit ($) Costs ($) Net cash flow ($) 0 - 15,000 (15,000) 1 3,000 - 3,000 2 3,000 - 3,000 3 3,000 - 3,000 4 3,000 - 3,000 5 3,000 5,000 (2,000) 6 3,000 - 3,000 7 3,000 - 3,000 8 3,000 - 3,000 9 3,000 - 3,000 10 3,000 - 3,000 The net cash flow diagram for machine B is given below. 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 0 1 2 3 4 5 6 7 8 9 10 (2,000) (15,000) Using the interest rate table in your text, manually calculate the NPV for each option. The NPV for the project can be calculated for each option separately by the following formula. NPV=t=110Ct1+rt-C0where C0=initial costr=interest rate=10%t=number of time periods=10Thus, the NPV for Machine A is The Present value of the profits for next ten years will be as follows. Year PV Factor Profit PV of Profit 1 1.111.1 1,800 1636.364 2 1.121.21 1,800 1487.603 3 1.131.331 1,800 1352.367 4 1.141.4641 1,800 1229.424 5 1.151.61051 1,800 1117.658 6 1.161.771561 1,800 1016.053 7 1.171.948717 1,800 923.6846 8 1.182.143589 1,800 839.7133 9 1.192.357948 1,800 763.3757 10 1.1102.593742 1,800 693.9779 Total 11060.22 The salvage value at year 10 will be $2,000, thus the present value of of this amount will be PVsalvage value=$20001.15=$1241.843The overhaul cost in year 5 will be $0, thus the NPV would be NPV=PVprofits+PVsalvage value-PVoverhaul cost-C0NPV=$11060.22+$1241.843-0-$10,000=$2302.063Now, the NPV of machine B can be calculated similarly. The Present value of the profits for next ten years will be as follows. Year PV Factor Profit PV of Profit 1 1.111.1 3,000 2727.273 2 1.121.21 3,000 2479.339 3 1.131.331 3,000 2253.944 4 1.141.4641 3,000 2049.04 5 1.151.61051 3,000 1862.764 6 1.161.771561 3,000 1693.422 7 1.171.948717 3,000 1539.474 8 1.182.143589 3,000 1399.522 9 1.192.357948 3,000 1272.293 10 1.1102.593742 3,000 1156.63 Total 18433.7 The salvage value at year 10 will be $4,000, thus the present value of of this amount will be PVsalvage value=$40001.15=$2483.685The overhaul cost in year 5 will be $5000, thus the PV would be PVoverhaul cost=5000(1.1)5=$3104.607NPV=PVprofits+PVsalvage value-PVoverhaul cost-C0NPV=$18433.7+$2483.685-$3104.607-$15,000=$2812.778Based upon the NPV values, which machine is the better option? Does either option earn less than the required MARR? Explain your answer. Solution Net Present Value illustrates the present value of future cash flows where the initial cost is subtracted from it. The positive NPV makes the option more attractive while a negative NPV discourages to pursue the project. In this case, the NPV of machine B is more than the NPV of machine A. Thus, this represents that the project with machine B is a better option for the manufacturer. The IRR for machine A and machine B is 12% and 13% which is calculated using the excel tools. Thus, as the IRR for the two options is equal and greater than the MARR we can say that the two options earn equally or greater than the MARR. Manually calculate ERR for each option. Based upon the ERR values, which machine is the better option? Does either option earn less than the required MARR? Explain your answers. For the ERR we have to calculate the discounted cash outflows and cash inflows. Thus, for machine A and machine B options the ERR will be as follows. The discounted cash out flows are of two kinds, the initial costs and the overhaul cost during the ten year of time period. Then the following table illustrates the discounted cash outflows for machine A and B together. Costs Machine A Machine B Initial costs $10,000 $15,000 Overhaul costs at year 5 $0 $5,000 Discounted cash outflows PV0=-$10000-0=-$10,000PV0=-$15,000-$5,0001.15=$18104.6Now the future value of the cash inflows for the two machines are given below Year PV Factor Profit Future Value Machine A Machine B Machine A Machine B 1 1.111.1 $1800 $3000 1980 3300 2 1.121.21 $1800 $3000 2178 3630 3 1.131.331 $1800 $3000 2395.8 3993 4 1.141.4641 $1800 $3000 2635.38 4392.3 5 1.151.61051 $1800 $3000 2898.918 4831.53 6 1.161.771561 $1800 $3000 3188.81 5314.683 7 1.171.948717 $1800 $3000 3507.691 5846.151 8 1.182.143589 $1800 $3000 3858.46 6430.766 9 1.192.357948 $1800 $3000 4244.306 7073.843 10 1.1102.593742 $1800 $3000 4668.736 7781.227 Total 31556.1 52593.5 Now, comparing the PV of cash outflows and FV of cash inflows as following Machine A:$10,0001+i'10=$31556.11+i'10=$31556.1$10,0001+i'10=3.155611+i'=1.12178i'=1.1217-1i'=0.1217i'=12.17%Similarly, Machine B:$$18104.61+i'10=$52593.51+i'10=$52593.5$18104.61+i'10=2.904971+i'=1.11253i'=1.11253-1i'=0.112536i'=11.25%Thus, we have reached to the conclusion that ERRA>MRRERRB<MRRThus, we conclude that the manufacturer should choose the option for machine B. Set up an Excel spreadsheet to check your results in parts II and III. the spreadsheet should be appropriately formatted and labeled and easy for the reader to understand. The spreadsheet is attached with the calculation of NPV and IRR with excel tools.