Fonderia di Torino S.p.

A
Capital Budgeting
Group 1:
Abhishek Sharma
Cynthia Hanna
Mingjie Bai
Wilfred Kennedy Aldowine

Nov 7, 2016
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?
 Current Capital Investment Options

 To purchase a new fully Vulcan Mold-Maker Machine

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
Is the investment profitable
or not?
 What is the actual initial outlay of the new
machine?
 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

New Machine
Capital Expenditure = € 813,296.25

* Estimated Resale Value of the old machines = €130K

 How to finance the new machine? What is your
cost of capital?

 Weighted Average Cost of MARKET VALUE OF COMPANY'S CAPITAL

Capital - WACC = 9.86%
Equity Debt
 Compared with the hurdle
rate of 14%, WACC provides Ratio Ratio
33%
a very competitive rate for *Cost of 67% Interest
Equity = Rate =
financing the investment as 12.80% 6.80%
it is lower than the average
prevailing cost of capital in
the market

* Cost of Equity calculated based on a 5.3% Risk-free Return, Company’s Beta 1.25 and Equity Risk Premium of 6%
 Let’s compare Operating Cost per year of the existing
machines VS. the new machine
On old machines, the biggest allocation of the Operating cost is Labor Cost

€ 350,000.00 Old Machines New Machine

€ 300,000.00 On new machine, the biggest
€ 250,000.00 allocation of the Operating
€ 200,000.00
cost will be on Maintenance
supplies
€ 150,000.00
€ 100,000.00
€ 50,000.00
€-
Labor Cost Maintenance Maintenance Electrical Side Effects
Labor Cost Supplies Power Additional
Positive
 Total Operating Cost Comparison

€ 400,000.00
€ 351,409.60  Total
€ 350,000.00
∆ Operating Cost Operating
€ 300,000.00
Delta cost of old
€ 250,000.00
€ 232,090 machines is
€ 200,000.00 3x more
€ 150,000.00 € 119,319.60
than cost of
€ 100,000.00
the new
machine
€ 50,000.00
€-
Old Machines New Machine
Incremental Future Cash Flows that will be generated from
new machine
Depreciation
Year 7+8
€ 252,500

166,145 166,145 166,145 166,145 166,145 166,145

1 2 3 4 5 6

Initial Net Present Value PV of discounted

Cost NPV > 0 Cash Flows
€ 813,296.25 € 22,916.50 € 836,212.75

 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

* The above calculations are based on a Cost of capital with inflation rate of 3% YOY
The investment is profitable from
an financial perspective

But let’s look at some other

implications
What about the lay-off cost of the workers that have
are working on the old machines?

 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

* 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
 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
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
Appendix:
Details of the Calculations in the Excel file including all
sensitivity analysis with different scenarios
Thank You