Prairie Winds Pasta – Capital Budgeting Methods & Cash Flow Estimation
Summary of Case
Prairie Winds Pasta is experiencing a high demand for pasta from its customers. The customers demand delivery with in one week with a maximum allowance of 10 days. The facility is running at full capacity - 24 hours a day.
Define the term “incremental cash flow.” Since the project will be financed in part by debt, should the cash flow statement include interest expense? Explain.
Incremental cash flows is the difference between the cash flows a company will have if it implements the new project versus the cash flows the company will have if they choose not to embark on the project. Cash flows not attributable to the new project are irrelevant to the investment decision making process. Comparing the two cash flows will show how much better or worse off the company may be by implementing the new project.
Even though the project will be financed partially by debt, the cash flow statement should exclude interest expense. Interest expense is related to the cost of financing the project. It is the general principle of capital budgeting analysis to separate the investment or capital budgeting and financing decisions so that the capital budgeting evaluation of a project can be made independently of the financing costs.
Questions 2 through 11 relate to the initial decision of adding the second pasta machine:
What is Prairie Winds Pasta’s Year 0 net investment outlay for the new pasta equipment expansion project? (Hint: Use Table 1 as a guide)
|Net Investment | | |
|Outlay: | | |
|Equipment cost |$40,000,000 |
|Freight | |250,000 |