You are currently working as a contractor building state of the art airports. One of the managerial accountants of the company you work for comes to talk to you about the budget for a project on which you have taken the lead. He wants to know your estimate for the cost of the project. You know that your future with the company depends on your performance in relation to this budget. Your best guess for this project is that it will cost $2,000,000.
What do you say to your boss and why?
You are currently working as a contractor building state of the art airports. One of the managerial accountants of the company you work for comes to talk to you about the budget for a project on which you have taken the lead. He wants to know your estimate for the cost of the project. You know that your future with the company depends on your performance in relation to this budget. Your best guess for this project is that it will cost $2,000,000.
What do you say to your boss and why?
Related questions
Thorndike, a firm producing metal gaskets, is located in BedfordMA and is thinking about expanding operations in the South. At themoment, all of Thorndikeâs customers are in either New England orthe Midwest. There is also some feeling in the company that theCalifornia market is also ripe for expansion. Accordingly, as headof Strategic Planning, you are asked to perform the financialanalyses for these two possibilities. Given capital constraints,senior management believes that it can expand in only one of thetwo proposed markets. You give your team one month to come upprojected financial results. Each team is working independently andyou are assured that there is no communication between them. Team Ais working on the Southern project, while Team B is working on theCalifornia project. You ask each team to develop relevant cashflows for each of their projects. The following table is what theyprovide to you (all values in U.S. dollars).
Year | Cash Flow - Southern | Year | Cash Flow - California |
2015 | -2,500,000 | 2015 | -3,000,000 |
2016 | 500,000 | 2016 | -100,000 |
2017 | 550,000 | 2017 | 0 |
2018 | 600,000 | 2018 | 500,000 |
2019 | 650,000 | 2019 | 500,000 |
2020 | 750,000 | 2020 | 750,000 |
2021 | 800,000 | 2021 | 1,500,000 |
2022 | 850,000 | 2022 | 2,000,000 |
2023 | 1,500,000 | 2023 | 5,000,000 |
You are told that all cash flows,including those in 2023, are after tax. You question the Californiacash flows and are told that generating cash in the early years ofthe project will be difficult given strict state environmentallaws. However, the market for metal gaskets should really take offstarting in 2018. You are also told that the large cash inflow forCalifornia in 2023 mostly represents appreciated real estate. TeamA feels that no such real estate bonanza is likely for the Southernproject. The large cash flow in 2023 for the Southern projectassumes that the project will be sold to a competitor and that anew facility may or may not be considered at that time. You aretold to ignore this possibility of building a new facility. EricSmithson, Thorndikeâs Treasurer, is worried about the competitivemarket in California and insists that this riskier project besaddled with a high cost of capital. Specifically, he insists thatyou use a 20% WACC for the California project. You have learnedfrom experience not to go against him. For the Southern projectEric believes that a 15% cost of capital is appropriate. You willbe making the presentation to the board. Which project will yourecommend, if any, and why? You are asked to show all work.
