FIN 330 Module 7 Project Two Example

Investment Proposal: Propane Ice Machine Line

[Student Name]

Southern New Hampshire University

FIN 330: Corporate Finance

Project Two

[Instructor Name]

[Date]

The organization, setting and figures below are a composite written as a model document. No real employer, client, colleague or patient is described.

Investment Proposal: Propane Ice Machine Line

Summary for the Board

Management recommends approving phase one of the propane ice machine line: $40 million of equipment and $6 million of working capital, funded internally, with a decision on the $24 million phase two in two years. On our best estimates the phased plan has an expected NPV of $14.6 million at our 9.7 percent cost of capital, more than twice the one-step build, and its worst case is a loss of about $3.5 million rather than $20.7 million. The line answers federal limits on high-warming refrigerants that are moving our customers toward propane equipment, and it does so without new shares or a strain on our borrowing limits.

Background

Restaurants, bars and cafés are replacing older ice machines as rules under the American Innovation and Manufacturing Act limit high-warming refrigerants. Compact propane-cooled machines are the fastest-growing part of that market, and we sell few compact units today. Module Five's analysis found a positive NPV of $6.3 million but showed that modest shortfalls in volume or price, or a one-year delay, would turn it negative. This proposal refines that analysis and examines how to reduce the risk.

Refined Cash Flows

The earlier analysis used straight-line depreciation for simplicity. For tax purposes, manufacturing equipment of this kind falls in the seven-year class under the Modified Accelerated Cost Recovery System, which allows larger deductions in the early years. Moving tax savings earlier raises the base-case NPV from $6.3 million to $8.0 million. Under current federal law the company may be able to deduct the full equipment cost in the first year as bonus depreciation; the tax department is confirming eligibility, and if it applies, the base-case NPV rises to about $11.0 million. This proposal uses the seven-year schedule as the conservative case.

Scenarios

Rather than change one input at a time, three scenarios move volume, price and costs together, reflecting how demand, competition and the economy interact.

Scenarios for the one-step build (seven-year depreciation, 9.7%)

The expected NPV is positive, but a one-in-four chance of losing more than $20 million is a large exposure for a single product line. Graham and Harvey (2001) found that most companies use scenario analysis for major projects, and here it changes the conversation from whether the project is positive to how much risk the board is willing to accept.

A Phased Build

The project does not need to be built all at once. Phase one would install equipment for 5,000 machines a year at a cost of $40 million, plus $6 million of working capital and fixed costs of $5.5 million a year. Phase two, $24 million of equipment and $3 million of working capital at the end of year two, would expand capacity to the full plan, but only if second-year sales reach at least 4,500 machines. If they do not, the company keeps the smaller line, which still serves the market at a modest loss rather than a large one.

Dixit and Pindyck (1994) show that the ability to wait for information before committing more capital has value that a standard NPV ignores. The phased plan captures it.

Phased build compared with one-step build

Phasing improves every case. The base case improves because the first two years' sales fit within phase-one capacity, so $24 million of spending is delayed with little lost revenue. The worst case improves most, because the second phase is never built.

Strategic Value

Dealers increasingly want to buy a full range of propane equipment from one supplier. If we cannot offer compact units, some may shift orders for our larger machines to rivals. If the line protected even $2.5 million a year of contribution on existing products from year three, the one-step base-case NPV would rise by more than $8 million. That benefit is uncertain and not included in the figures above, but it points in the same direction.

Financing

Phase one needs $46 million, matching the working capital that Module Two found tied up beyond peer levels. Shortening dealer payment terms by fifteen days over two quarters and clearing older-refrigerant inventory should release most of it within eighteen months. Any timing gap would be covered by the $100 million revolving line, keeping debt at or below 2.3 times EBITDA, well inside the 3.0 covenant. No new shares are needed. Phase two, if approved, could be funded from the line's own cash flow and modest borrowing.

Alternatives Rejected

Two other options were considered. Licensing a propane design from a European maker would cost less up front, about $18 million for tooling, but would carry royalties of 6 percent of sales and leave the company dependent on a supplier that also sells to rivals; its expected NPV was lower than the phased build in every scenario. Delaying the whole project by two years to watch the market would avoid risk but would likely cost the company its position with dealers, since two competitors have already announced compact propane models. Waiting entirely gives up the part of the market the line is meant to win.

Risks and Controls

Management will report quarterly on unit sales against plan, average price, contribution margin and the release of working capital. The phase two decision will rest on year-two sales of at least 4,500 machines and a contribution margin of at least 32 percent. Koller et al. (2020) note that value is created by executing well after approval, not only by choosing well, and these checkpoints are designed to keep the board informed.

Recommendation

The board should approve phase one at $46 million, funded internally, and set the year-two checkpoint for phase two. The phased plan offers an expected NPV of $14.6 million, remains positive at 11 percent and limits the worst case to a manageable loss.

References

Dixit, A. K., & Pindyck, R. S. (1994). Investment under uncertainty. Princeton University Press.

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.