Financial Economis

Bentley Custom Ceramics

1) Mr Reynolds informed Julianthat his loan application to purchase either type of kiln including installation and expert testing has been approved. The terms of the loan would be payment of yearly interest in advance at a fixed rate of 12% per annum over the life of the project and repayment of the principal owing at maturity.

2) The estimated service life for a gas-fired kiln is 10 years and six years for an electric kiln. The salvage values for a gas-fired kiln and an electric kiln at the end of their usable lives are $4,000 and zero , respectively. Julian’s accountant allocated depreciation to the gas-fired kiln in the modified accelerated cost recovery (MACRS) 10-year class and the electric kiln could be depreciated using the MACRS category for 5-year assets. Depreciation allowance percentages according to MACRS are shown in the table below.

MACRS Allowance Percentages

Year 5-year assets 10-year assets

1 20% 10%

2 32% 18%

3 19% 14%

4 12% 12%

5 11% 9%

6 6% 7%

7 7%

8 7%

9 7%

10 6%

11 3%

3) As you were checking the sales and cost projections for the new kilns provided by Julian in Exhibit 4, you noted that he had not made a provision for the increased working capital requirements with the new equipment. This would entail an initial increase in accounts receivable of $10,000, an increase in accounts payable of $15,000, and an increase in inventory of $25,000. Net working capital requirements for subsequent years will be 10% of additional sales.

4) You had learnt in your postgraduate finance course that project cash flows typically have different levels of risk. You had a discussion with Julianto get a feel for the uncertainties involved the cash flow estimates. Julian concluded that there was little uncertainty in any of the estimates except for the sales projection, which could vary significantly depending on the market demand. In his opinion, the sales projection could deviate from the estimated figure given in Exhibit 4 by plus or minus 20%.