Metalcrafters Inc. was founded in the late 1970s and originally specialized in producing polished and anodized aluminum hardware and molding parts for the auto industry. Over the years, MetalCrafters has diversified to producing parts outside of the auto industry to the point where in 1999, over half the parts produced and 40% of the revenue were not associated with the auto industry.
Capital investments that are more than $5,000 need to be approved by the budget committee. In September 2000, a new stamping press and an extrusion press were requested. Two models of the stamping press and the extrusion press were under consideration. The SX-65 costs $65,000 and is expected to last 5 years. The MD-40 is more durable and is expected to last 10 years at a cost of $90,000. For the Extrusion Presses, Metalcrafters will have to choose between a small press costing $650,000 and a large press costing $1,000,000. Due to capacity constraints, Metalcrafters can only choose 1 to order. Additionally, management had to choose between 2 parts orders between Eades Electric and Sawmasters due to limited capacity. Analysis of the future cash flows from each press is located in the appendix. The NPV method was the preferred evaluation method for reasons mentioned in the following section. The further analysis will show why the MD-40 prevails against the SX-65 as well as why the larger extrusion press is favorable to the smaller one. In addition, the Sawmasters order was more favorable than the Eades Electric order. Possible changes in the tax code along with non-financial issues are brought up for additional consideration that can influence the recommendation. Evaluation Method
First of all, we believe it is necessary to ensure the evaluation method to be adopted for the future projects evaluation. So far, Metalcrafters’ board members were using 3 different methods to evaluate the projects. The three methods are internal rate of returns (IRR), net present value (NPV) and payback period. We believe that by adopting one superior method, the future evaluation process would be simplified and take less time than that of the current process. Based on our experience, the payback period method is dominated by the other two methods because this method only considers the paybacks with nominal returns, which doesn’t count the effect of the time value of money. The IRR method does consider the time value of money It is good to determine whether a project can meet the company’s investment standards (required rate of returns), and the higher the better. Similar to the IRR, the NPV method also calculates the impact of the time value of money. A positive NPV means the project meets the required rate of returns, and the higher the better. Usually, those two methods both can do good jobs to evaluate projects. When IRR is higher than the required rate of returns, or the NPV is positive, the investors can accept the deal. However, we value NPV method more than the IRR method because it also considers the opportunity cost of money and can give investors a direct feeling of changes. For example, when investors have to evaluate mutually exclusive projects, some projects require little initial investment, and provides mild future cash flows; it can give us a high IRR. But this project is limited because it can only provide the investment opportunity for a small amount of money. Because of the mutually exclusive condition, the rest money will earn zero returns. In the other hand, if a project requires large initial investment, and can provide high future cash flows, it will probably have a mild IRR, but very high net present value, which gives acceptable high enough returns to the most money that investors hold. Besides, when comparing different projects, NPV (if positive) can directly show how much more investors can earn than the normal returns. It may help investors to determine the superior projects easier. In our case, because of...
Please join StudyMode to read the full document