Claires Antiques Essay Example | Topics and Well Written Essays - 1500 words

Claires Antiques - Essay Example It should be noted that as the company currently has a level limited of resources, only one of these alternatives will be chosen. To aid in the decision making, this presentation will utilize a Net Present Value (NPV) analysis to the projected cash flows of both projects. Considering that cost of capital may vary from Claire's antiques expectations, we will also employ sensitivity analysis to look at the value of the two alternatives' NPVs in different cost of capital. We will further assume that the risk-based cost of capital is 10% and that the project has a tax rate is 40%. Also, the company will be using straight line depreciation method to adjust the book value of the facility. Another assumption is that, the company will be using either North or West Warehouse for five years, after which the facility will be sold in cash in its book value or salvage value. Also, this presentation assumes the depreciation expense is not yet included in the presumed annual fixed costs. NPV is used in capital budgeting to analyze the profitability of an investment or project. NPV is the difference between the present value of cash inflows and the present value of cash outflows (Net Present Value 2006). If the NPV is positive, the investment is accepted. In contrast, negative NPV means that an project is not profitable. The evaluation of the alternatives begins with the laying out of the expected cash flows. In an NPV analysis, cash outflows and inflows are further discounted to take into account the time value of money. After that, the NPVs of the two options are compared. Based on the data given by the private firm, North Warehouse will have the following cash flows for 5 years: 1. advertising expense of $140, 000 in year 0 2. sales revenue in year 1 is $650, 000 and will grow at an annual rate of 7% 3. contribution margin is 55% of the total revenue 4. annual fixed cost is $100, 000 5. $1, 500, 000 investment in facility 6. estimated salvage value of $125, 000 7. yearly depreciation of $275, 0001 Table 2 shows the discounted cash flows from the first alternative. Please note that the figures in black are inflows of cash while the figures in red indicate the opposite. Total Cash outflow and outflow for the fiscal year are discounted using the present value factor. Table 2. Cash Flows of Option 1: North Warehouse Option 1 or using the North Warehouse yields a positive NPV of $7, 181.00 utilizing a risk-adjusted cost of capital of 10%. Evaluation of Option 2: West Warehouse Based on the data given by the private firm, North Warehouse will have the following cash flows for 5 years: 1. incur an advertising expense of $150, 000 in year 0 2. sales revenue in year 1 is $900, 000 and will grow at an annual rate of 8% 3. contribution margin is 45% of the total revenue 4. annual fixed cost is $120, 000 5. $1, 700, 000 investment in facility 6. estimated salvage value of $120, 000 7. yearly depreciation of $316, 0002 Table 3 shows the cash flow/inflow of Option 2 which is the West Warehouse. Based on the cash