Case 82

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Case #82

Prairie Winds Pasta – Capital Budgeting Methods & Cash Flow Estimation

Summary of Case

Question 1

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.

Response:

Questions 2 through 11 relate to the initial decision of adding the second pasta machine:

Question 2

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)

Response:

Question 3

Since Prairie Winds already owns space in the production facility, is this space “free” or “costless” from the standpoint of the additional pasta machine? Explain how the $100,000 in annual rent the company currently receives for space in the facility should be included in the analysis.

Response:

Question 4

The addition of competing product lines with a cheaper grade of pasta has been raised. What additional concerns about the high-grade pasta machine must be considered if the company decides to introduce a competitive pasta product to its existing offerings? What if it were believed that if Prairie Winds did not introduce the cheaper product, a competing firm would develop a very similar product? How would Prairie Winds’ decision to purchase the new high-grade pasta machine be affected?

Response:

Question 5

What are the expected non-operating cash flows when the project is terminated in Year 10?

Response:

Question 6

Estimate the project’s operating cash flows for each year of the project’s economic life. (Hint: Use Table 2 as a guide)

Response:

Question 7

What discount rate should be used as the company’s cost of capital?

Response:

Question 8

Compute the project’s NPV, IRR, modified IRR (MIRR), payback and PI, and explain the rationale behind each of these capital budgeting models.

Response:

Question 9

Based on each model,...