1. Fonderia di Torino S.p.A
Capital Budgeting
Group 1:
Abhishek Sharma
Cynthia Hanna
Mingjie Bai
Wilfred Kennedy Aldowine
Nov 7, 2016
2. Fonderia di Torino: Current Situation
Current Situation: With its strong partnerships in the
Automotive industry and its reputation for quality
products, Fonderia di Torino is one of the top companies
in Italy specialised in the production of precision metal
castings used in several industries
Challenge: How can Fonderia di Torino reduce cost,
improve production quality and reduce rejection rate of
its parts by OEMs?
3. To purchase a new fully
automated molding
machine operated with
only two skilled
operators providing 30%
more floor space with
higher levels of
production quality
Investment Required:
€ 1,01 million
Current Capital Investment Options
Vulcan Mold-Maker Machine
5. What is the actual initial outlay of the new
machine?
New Machine
Capital Expenditure = € 813,296.25
Total investment of new machine is
€1.01million, but with the Capital Loss
from the Sale of the old machines
deducted from the overall asset
acquisition cost, the initial outlay will
be much less
* Estimated Resale Value of the old machines = €130K
6. How to finance the new machine? What is your
cost of capital?
Weighted Average Cost of
Capital - WACC = 9.86%
Compared with the hurdle
rate of 14%, WACC provides
a very competitive rate for
financing the investment as
it is lower than the average
prevailing cost of capital in
the market
Debt
Ratio
Equity
Ratio
MARKET VALUE OF COMPANY'S CAPITAL
Interest
Rate =
6.80%
*Cost of
Equity =
12.80%
33%
67%
* Cost of Equity calculated based on a 5.3% Risk-free Return, Company’s Beta 1.25 and Equity Risk Premium of 6%
7. Let’s compare Operating Cost per year of the existing
machines VS. the new machine
€ -
€ 50,000.00
€ 100,000.00
€ 150,000.00
€ 200,000.00
€ 250,000.00
€ 300,000.00
€ 350,000.00
Labor Cost Maintenance
Labor Cost
Maintenance
Supplies
Electrical
Power
Side Effects
Additional
Positive
Old Machines New Machine
On old machines, the biggest allocation of the Operating cost is Labor Cost
On new machine, the biggest
allocation of the Operating
cost will be on Maintenance
supplies
8. Total Operating Cost Comparison
Total
Operating
cost of old
machines is
3x more
than cost of
the new
machine
€ 351,409.60
€ 119,319.60
€ -
€ 50,000.00
€ 100,000.00
€ 150,000.00
€ 200,000.00
€ 250,000.00
€ 300,000.00
€ 350,000.00
€ 400,000.00
Old Machines New Machine
∆ Operating Cost
Delta
€ 232,090
9. Incremental Future Cash Flows that will be generated from
new machine
As per the NPV method of capital investment, projects with positive NPVs are profitable
With this investment, you will be making a profit of approx. €23K
Depreciation
Year 7+8
€ 252,500
Initial
Cost
€ 813,296.25
1 2
166,145 166,145 166,145 166,145 166,145 166,145
3 64 5
PV of discounted
Cash Flows
€ 836,212.75
* The above calculations are based on a Cost of capital with inflation rate of 3% YOY
Net Present Value
NPV > 0
€ 22,916.50
10. The investment is profitable from
an financial perspective
But let’s look at some other
implications
11. What about the lay-off cost of the workers that have
are working on the old machines?
* Savings from new machine calculated based on the difference between incremental cash flows per year
and cost of capital per year and an inflation rate of 3% YOY
As per the Italian
labor law, employees
are to be paid a 6
months compensation
to be laid off
In your case, even if
you decide to pay a
total of 1 year salaries,
you would still be
making a profit from
the new machine
12. Economy Outlook for the coming years…
Current Expected Inflation is 3% Year on Year
But the economy looks like it’s heading to a slow-down – which is a concern
Based on a sensitivity analysis and simulations for your capital investment, your
inflation threshold to keep a positive NPV is 5% YOY
With a 5% Inflation rate, your weighted average cost of capital would reach a maximum
of 13.21% which would still be lower than the current hurdle rate of 14%
Even if the economy slows down more than expected, you would still be profiting from
the new investment as you have a 2% margin / safety cushion from the increasing
inflation rates pushing higher your cost of capital
13. Non-Financial implications reinforcing your decision
to go ahead with the new machine acquisition
The extend of which the new machine will improve your quality of production
Reducing Operational cost
Reducing Labor Costs by 90% and minimising any potential lawsuits that might
arise between the company and Labor Unions
Reducing scrap rate / rejection rate
Saving space in the factory up to 30% which could be used for storage or other
new assets
Maintaining your reputation as a market leader in new technology and leading the
way in the progress in the industry
14. Appendix:
Details of the Calculations in the Excel file including all
sensitivity analysis with different scenarios
