GM506 Unit 5 Second Truss Plant Investment Appraisal Example

A Second Plant 150 Miles Away: A Unit 5 Investment Appraisal for a Truss and Panel Manufacturer

[Student Name]

Purdue University Global

GM506: Strategic Financial Analysis

Unit 5 Investment Appraisal

[Instructor Name]

[Date]

Haddon Truss and Panel, the project and every figure are composite and illustrative; the methods and sources cited are real.

The Project

Haddon proposes to build a second truss and panel plant near the metro market where most of its distant builders work, about 150 miles from its home plant. The new plant would serve those builders directly, so jobs now hauled from the home plant would move to it, and it would compete for new work in a growing market.

The Assumption Panel

Every result below depends on eight assumptions, each listed with its value and source.

Construction cost: $15.5 million, including $1.6 million for land. Source: a contractor's budget estimate and a land option the family already holds.

Mature revenue: $17.0 million a year, reached in year four. Revenue ramps from 30 percent of that level in year one to 60 percent in year two and 85 percent in year three, then grows 2 percent a year. Source: the sales manager's estimate of distant jobs that would move plus new metro builders, reviewed against the metro market's permit data.

Contribution margin: 30 percent of revenue. Source: the home plant's contribution margin on comparable work, adjusted for local wages.

Hauling saved: $1.3 million a year. Source: the delivery-by-distance schedule, applied to jobs that would move from the home plant to the new one.

Plant fixed costs: $2.5 million a year. Source: the home plant's fixed costs scaled to the new plant's size.

Working capital: 22 percent of revenue. Source: the company's current receivables and inventory relative to sales.

Depreciation: straight line over fifteen years on the $13.9 million of buildings and equipment. Source: the company's depreciation policy.

Tax rate: 25 percent. Source: the outside accountant's blended rate.

The Cash Flows

The model computes each year's after-tax operating cash flow as contribution plus hauling saved, less fixed costs and depreciation, taxed at 25 percent, with depreciation added back and the increase in working capital subtracted. Year zero is the construction outlay of $15.5 million. Year one is slightly negative, at about minus $0.6 million, because the plant reaches only 30 percent of mature revenue while working capital builds. Cash flow turns positive in year two at about $0.5 million, reaches about $2.6 million in year four and grows to about $3.6 million by year ten as revenue rises 2 percent a year.

Terminal Value

After year ten, the plant is assumed to continue indefinitely, with cash flows growing 2 percent a year and maintenance capital spending equal to depreciation. That terminal value, about $31.7 million at the end of year ten, is worth about $11.7 million today at the 10.5 percent hurdle. Corporate finance texts treat terminal value as a necessary part of valuing a long-lived asset and warn that it often dominates the result, so its assumptions deserve the closest scrutiny (Koller et al., 2020).

Results

Net present value at 10.5 percent: about $8.6 million.

Internal rate of return: about 14.4 percent.

Payback: about seven and a half years, with cumulative cash turning positive during year eight.

What the Results Mean for the Owners

The project clears the owners' hurdle. Its expected return of about 14.4 percent exceeds the 10.5 percent they require, and the plant would add about $8.6 million of value in today's dollars. That is a substantial gain for a company whose invested capital is about $35 million.

But the composition of that value matters. The present value of the terminal value, $11.7 million, is larger than the whole net present value. In other words, the first ten years of cash flows, taken alone, are worth about $3.1 million less than the plant costs. The project creates value only if the plant keeps operating profitably beyond year ten.

The plant earns its keep in its second decade; judged on its first ten years of cash alone, it would leave the owners about $3.1 million short of their hurdle.

That is not unusual for a manufacturing plant with a long life, but it means the owners are making a twenty-year commitment, not a ten-year one. It also means the result is sensitive to anything that would shorten the plant's useful life, such as a slump in the metro housing market or a change in building methods.

Why Net Present Value Leads

Surveys of financial executives find that internal rate of return and payback are widely used alongside net present value, and that smaller private firms rely on payback more heavily than large ones (Graham & Harvey, 2001). This appraisal reports all three, but net present value leads, since it reports the owners' gain in dollars and counts the long tail of cash flows properly. Payback ignores everything after year eight, which here is most of the value. The internal rate of return is a handy summary, though it can rank projects of unequal size the wrong way (Brealey et al., 2023).

Assumptions That Need Testing

Three assumptions carry the most weight: mature revenue, the contribution margin and the hauling saved. The sensitivity analysis in Unit 8 tests each across a realistic range. The construction cost is a budget estimate that could rise, and the discount rate reflects the owners' hurdle rather than a market estimate.

References

Brealey, R. A., Myers, S. C., & Allen, F. (2023). Principles of corporate finance (14th ed.). McGraw Hill.

Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics, 60(2-3), 187-243. https://doi.org/10.1016/S0304-405X(01)00044-7

Koller, T., Goedhart, M., & Wessels, D. (2020). Valuation: Measuring and managing the value of companies (7th ed.). Wiley.