A Case Study

on
Shaftel Ready
Mix
Group 5
Exiomo, Maryanne D.
Lizardo, Regina Lour
Santiago, Chamuel Michael Joseph A.
Santos, Maria Creselda B.

Synthesis
Shaftel Ready
Mix

Concrete,
aggregate and
rock products

Synthesis
Shaftel Ready
Mix
Concrete and
Aggregate
Products

3x Gross
Revenue in 10
Years

Synthesis

Shaftel Ready
Mix

Statement of the Problem/s

How viable is the proposed construction of

additional plant in Scottsdale, Arizona?
What is the significance of determining Net
Present Value (NPV), Internal Rate of Return
(IRR), payback period and break even point for
the proposed plant?
How must the company respond to the proposal
of setting up a new plant in Scottsdale, Arizona?
How can the company determine whether
setting up a new plant will lead to a positive
return of sales at an acceptable period of time?

Point of View

CONTROLLER

Statement of the Objectives

To determine whether the

new plant in Scottsdale is a
worthy investment.

To compute for the proposed

plants ratio of net income
to sales, net present value
(NPV), internal rate of return
(IRR), payback period and
break even point.

To analyze how capital

investment tools (non
discounting and discounting
models) affect long run
decision making for the
company

Areas of Consideration

Capital
investment
decision
are
concerned with acquisition of long-term
assets such as the proposed Scottsdale
plant in this case.

The proposed plant is an independent

project, which means whether the proposal
is accepted or rejected, cash flow of other
projects of Shaftel will not be affected.

Areas of Consideration

Payback period determines the time

required for a firm to recover its original
investment.

Areas of Consideration

Areas of Consideration

Net
present
value
measures
profitability of an investment.

the

Interest rate of return is the interest rate

that sets the present value of a projects
cash inflow equals to the present value of
the projects cost.

Book Value not

considered:

NPV of $306,698
IRR that is between
25% and 30%
(df=3.28358)
Proposed plant will
be able to increase
the firms
profitability and the
project is
acceptable.

Areas of Consideration

At breakeven, the
plant
should
produce
29,859
cubic yards of
cement and using
the
break-even
amount, the NPV
is -$6,675 and
discount factor is
6.26335 which is
between
9
percent and 10
percent.

Alternative Courses of Action

ACA 1: Accept the proposal to set up a new
factory in Scottsdale, Arizona.
Pros:

Add $306,698 to its value.

It will be able to operate year round.
The payback period is less than 4 years.
Take advantage of untapped markets.
Maximize use of current assets (with total book value of
$230,000) which has no outside market value.

Cons:
The projected return of sales is lower than the companys
average.

Alternative Courses of
Action
ACA 2: Reject the proposal to set up a new
factory in Scottsdale, Arizona.
Pros:
Invested in a bank or other investment project at 10%
interest, the capital would be $912,997 in 10 years. Less
risky than investing on new capital.

Cons:
Inability to operate year round
Inability to take advantage of the exceptional growth rate
in Arizona.
Not able to maximize current assets (furniture and
equipment) available.

Decision matrix
Factors:
Return of
Investment
30%

Risk
20%

Profitability
/
Competitiv
eness
50%

ACA 1: Accept the proposal

to set up a new factory in
Scottsdale, Arizona.

20

15

45

80

ACA 2: Reject the proposal

to set up a new factory in
Scottsdale, Arizona.

25

19

25

69

Total
100%

Recommendation
ACA 1: Accept the proposal to set up a new factory
in Scottsdale, Arizona.

The company will be adding $306,698 to its value.

Positive Net Present Value (NPV), it shows that the proposed plant will
be able to increase the firms wealth and profitability.
IRR is between 25 to 30% which is greater than its cost of capital or
hurdle rate at 10%.
Improvement in the quality of products and reliability of the company.

The project would pay for itself less than the 4 years as per company
policy.
Take advantage of untapped markets.
Maximize use of old furniture from its closed down plant in Wyoming .

Learning Points

It is important to weigh risks and benefits

when determining capital investment
decisions.

One may determine if a proposed longterm

project
is
acceptable
using
discounting and non-discounting models.

Thank you

Annex

1. Prepare a variable-costing income statement for the proposed plant.

Compute the ratio of net income to sales. Is Karl correct that the return on
sales
is
significantly
lower
than
the
company
average?

With above variable-costing income statement, fixed overhead is treated as an expense.

Since the computed ratio of net income to sales turned to be 3.24%, Karl is correct in
stating that the Return on Sales (ROS) is significantly lower than the companys average
between 7.5 and 8.5%. This signifies that if the company would invest in the proposed
plant, it would earn less than 4.26 to 5.6% from the normal companys sale average.

2. Compute the payback period for the proposed plant. Is Karl right
that the payback period is greater than 4 years? Explain. Suppose
you were told that the equipment being transferred from Wyoming
could be sold for its book value. Would this affect your answer?

Karl is wrong. Book value of the equipment and the

furniture should not be included in the amount of the
original investment because there is no opportunity
cost associated with them. These items would only be
transferred from a plant that opened in another state,
Wyoming, during the oil boom period and closed a few
years. Excluding the book value reduces the
investment from $582,000 to $352,000. Karls payback
would be correct if the equipment and furniture could
be sold for their book value because there would now
be an opportunity cost associated with them and that
cost should be included in the original investment.

3. Compute the NPV and the IRR for the proposed plant. Would
your answer be affected if you were told that the furniture and
equipment could be sold for their book values? If so, repeat the
analysis with this effect considered.

Given two different situations regarding equipment and

furniture, whether these can be sold for their book values
or would only be merely transferred from one plant to
another, will have a great impact on our decision making
process. If these items will only be transferred from an old
plant to the proposed plant, it would generate IRR between
25 to 30%. Since the cost of capital is 10%, we may
conclude that the proposed plant should be accepted
because IRR is greater than its cost of capital. This will
result to a positive Net Present Value (NPV, resulting to an
increase in firms wealth profitability. On the other hand, if
these items can be sold for its book value, from aboves
computation, its new IRR turns out to be between 12 to
14%. Still, our new IRR is greater than cost of capital of
10%. We may conclude the proposed plants inflow is
greater than our initial outlay. However, it resulted to a
lower amount of profitability when compared with
equipment and furnitures merely transferred from the old
plant.

4. Compute the cubic yards of cement that must be sold for the new plant to
break even. Using this break-even volume, compute the NPV and the IRR.
Would the investment be acceptable? If so, explain why an investment that
promises to do nothing more than break even can be viewed as acceptable.

The investment is unacceptable. IRR is lower than its cost of

capital of 10% which results to a negative NPV. However, it
is also possible to have a positive NPV at the break-even
point. Breakeven is defined for accounting income, not for
cash flow. Since there are non cash expenses deducted from
revenues (ie. depreciation), accounting income understates
cash flow income. Zero income does not mean zero cash
inflows and vice versa. Suppose we have $ 100,000 as our
depreciation expense and everything remain constant, it
would result to a positive NPV of $ 262,457 cost of capital at
10%. Its IRR has been computed between 25 and 26% which
is greater than its cost of capital at 10%. IRR = $352,000
(initial investment) / 100,000 (yearly cash flow which is
depreciation) = 3.52 (present value factor of annity).

5. Compute the volume of cement that must be sold for

the IRR to equal the firms cost of capital. Using this
volume, compute the firms expected annual income.
Explain this result.

Cost of Capital = 10% for 10 years, so df

= 6.14457

An alternative solution is as follows:

From above computation, we can conclude

selling 30,017 or 29,968 units (rounding off
difference) will result in Internal Rate of
Return (IRR = 28%) to equal with projects
cost of capital (10%). At this rate,
companys net income is close or at zero.
Once the company gets to sell more than
29,968 units, it is safe to say that for every
unit sold thereafter, they have covered for
their fixed costs and already earned net
income.