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Fonderia di Torino (Fdt) produces specialised metal castings for the automotive automotive,
aerospace and construction industries. FdT's managing director is Francesca Cerini
grandfather, Benito Cerini, founded the company in 1912 . With customers mainly based in
Europe, FdT has various strategic alliances including BMW, Ferrari and Peugeot based on
the production quality. While FdT is list on the Milan stock market the Cerini family
continues to own 55% of the shares of the stock.
FdT's traditional hurdle rate of return on capital is 14% and the historical company policy
seeks payback of an investment within 5 years. FdT's current liabilities are funded by 33%
debt and 67% equity. The debt consists of loans from Banco Nazionale di Milano with an
interest rate of 6.8%. Company's effective tax rate is 43%.
Problem identification
FdT is facing an investment decision. The company can buy a Vulcan Mold-Maker machine
for 1.01 million Euros which could replace six of current semi-automated machines. The new
machine requires only 2 operators (1 per shift) as opposed to 6 current machines which
require 24 workers (12 workers per shift) plus 3 maintenance workers. The new machine will
also free about half of the space currently occupied by current machines.
Additionally , the Vulcan Mold-Maker Machines capacity is 30% bigger than the capacities
of the current machines. It also produces products of better quality and lower scrape rates that
the company is currently boasting.
economic news from Europe suggests that there will be a slowdown and FdT may face
reduced sales. While the FdT manufactures products for top of the line cars, sales would
seem to be inelastic to economic slowdowns. Considering weather or not to expand during an
economic slowdown should be kept in mind.
The effect of inflation was briefly looked at in the analysis of the reduction of operating costs
(results in section "Possible criticalities, conclusions and recommendations").
Depreciation of the old machines is given as €47,520. Depreciation for the Vulcan Mold-
Maker is 1,010,000/ 8 years = €126,250 pa.
Old Machines
Vulcan Mold-Maker
Given Information:
Number of machines
Semi-Automated machines
415807.00
1010000.00
Cummulative depreciation
130682.00
0.00
Net Book
285125.00
1010000.00
Depreciation Average
47520.83
126250.00
Maturity
Useful Life
Depreciation p.a.
69300.33
126250.00
130000
Calculation
12
Shift
210
210
Hourly rate
7.33
11.36
Cost of workers
295545.60
38169.60
Maintaince workers per shift
Shift
210
Hourly rate
7.85
39564
Cost of maintenance supplies
4000
59500
Electrical Power
12300
26850
-5200
This percentage was calculated by multiplying the cost of each capital by its weight and then
adding the two.
The weight of debt was given as 33%. The cost of debt given was 6.8% (based on the interest
rate of loans from from Banco Nazionale di Milano).
The weight of equity was given as 67%. The cost of equity used was 9.86%.
This number was calculated by multiplying the company's beta of 1.25 by the equity risk
premium of 6% and adding it to the risk free return of 5.3%. The beta, equity risk premium
and risk free return were given in the case.
Cost
C1
C2
€ 232,090.00
Deprec.
D1
D2
€ (78,730.00)
EBIT
(S-C1-D1)
€ 303,889.60
(S-C2-D2)
€ (6,930.40)
EBITDA
(S-C1-D1)*(1-T)
€ 173,217.07
(S-C2-D2)*(1-T)
€ (3,950.33)
Cash flow
(S-C1)*(1-T)+D1*T
(S-C2)(1-T)+D2*T
Cash flow difference is greater than cost of capital of €80,225.20 (9.86% x 813,643)
Main conclusions/findings/insights
Given cash flow generated from investment in the Vulcan Mold-maker is greater than the
overall cost of capital by €85,920 this would make the new machine a viable investment
based purely on the financials. The SWOT and recommendations give a holistic review of the
overall considerations.
Inflation
WACC
Present Value
9.86%
€ 166,145.20
€ 151,233.57
3%
10.16%
€ 166,145.20
€ 136,921.95
3%
10.46%
€ 166,145.20
€ 123,272.75
3%
10.77%
€ 166,145.20
€ 110,339.73
3%
11.10%
€ 166,145.20
€ 98,167.12
3%
11.43%
€ 166,145.20
€ 86,789.00
3%
11.77%
€ 252,500.00*
€ 129,488.63
Present Value
€ 836,213
* Resale value
Weaknesses/Opportunities
This provides a cushion in the WACC of almost 3% for any changes in the cost of debt or the
cost of equity that may cause the WACC to increase.
Any decrease in the WACC would prove the purchase of the new machine to be even more
profitable.
Utilizing the WACC computed above, a review of the annual cash flows for the new project
shows a positive net present value (NPV).
As a sensitivity, if an inflation rate of 5% were applied to the operating costs for the life of
the new machine, the purchase of new machine would just be borderline favourable.
The new machinery will imply higher quality of products which has proven to be a key factor
in FdT negotiating longer-term contracts.
Another benefit is that FdT has the potential to down size it's work force. This may require
careful negotiations with the appropriate labour unions. Unfortunately based on the
information provided, workers laid-off could only be re-deployed as janitors which would not
likely be acceptable to both workers and unions.
A large part of the success of the purchase of the new machinery relies on the If cost savings
are generated from work force reductions.
While a reduced work force would imply a decrease in medical claims and decreased
insurance costs, if negotiations with the union are not positive (and combining this was a
potential slowdown in Europe), then a viable recommendation could be to postpone the
purchase of the new machine.