Overviewshoals Corporation Puts Significant Emphasis On Cash Flow When ✓ Solved

Overview Shoals Corporation puts significant emphasis on cash flow when planning capital investments. The company chose its discount rate of 8 percent based on the rate of return it must pay its owners and creditors. Using that rate, Shoals Corporation then uses different methods to determine the most appropriate capital outlays. This year, Shoals Corporation is considering buying five new backhoes to replace the backhoes it now owns. The new backhoes are faster, cost less to run, provide for more accurate trench digging, have comfort features for the operators, and have 1-year maintenance agreements to go with them.

The old backhoes are working just fine, but they do require considerable maintenance. The backhoe operators are very familiar with the old backhoes and would need to learn some new skills to use the new backhoes. The following information is available to use in deciding whether to purchase the new backhoes: Old Backhoes New Backhoes Purchase cost when new ,000 0,000 Salvage value now ,000 Investment in major overhaul needed in next year ,000 Salvage value in 8 years ,000 ,000 Remaining life 8 years 8 years Net cash flow generated each year ,425 ,900

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Introduction

Capital investment decisions are critical for any company aiming for growth and efficiency. At Shoals Corporation, significant emphasis is placed on cash flow considerations when assessing capital investments. The company’s approach is reflective of modern investment theories that prioritize the time value of money and return on investment (ROI). This report analyzes the decision-making process regarding the acquisition of five new backhoes, comparing them with the old models. The analysis includes a review of cash flows, salvage values, and overall investments associated with each option, employing discounted cash flow methods for a comprehensive financial assessment.

Financial Parameters

Current Backhoes

- Purchase Cost (when new): ,000 each
- Salvage Value (now): ,000 each
- Investment in Major Overhaul: ,000 (required in the next year)
- Remaining Life: 8 years
- Net Cash Flow Generated (per year): ,425

New Backhoes

- Purchase Cost: 0,000 each
- Salvage Value (in 8 years): ,000 each
- Remaining Life: 8 years
- Net Cash Flow Generated (per year): ,900

Cash Flow Analysis

To conclude whether Shoals Corporation should invest in the new backhoes or continue with the current models requires a net present value (NPV) analysis. The discount rate of 8% is applied, aligning with the expected rate of return for both owners and creditors.

1. Net Cash Flow Calculation

Old Backhoes

Annual Cash Flow:
\[
Net Cash Flow = $30,425
\]
Total Cash Flow over 8 years (without discounting):
\[
Total Cash Flow = 30,425 \times 8 = $243,400
\]
Salvage Value at Year 8:
\[
Total Cash Flow (including salvage) = 243,400 + 42,000 = $285,400
\]

New Backhoes

Annual Cash Flow:
\[
Net Cash Flow = $43,900
\]
Total Cash Flow over 8 years (without discounting):
\[
Total Cash Flow = 43,900 \times 8 = $351,200
\]
Salvage Value at Year 8:
\[
Total Cash Flow (including salvage) = 351,200 + 90,000 = $441,200
\]

2. Present Value Calculation

Next, we will calculate the present value (PV) of the cash flows for both options using the formula for present value of an annuity, adjusted for the salvage values.
Present Value of Cash Flows for Old Backhoes:
\[
PV_{old} = \sum_{t=1}^{8} \frac{30,425}{(1 + 0.08)^t} + \frac{42,000}{(1.08)^8}
\]
Using an annuity table or calculating directly, the present value of cash flows can be computed for each year (t).
After calculating:
- Present Value of Net Cash Flows without Salvage: ≈ 7,771
- Present Value of Salvage Value: ≈ ,619
Total Present Value for Old Backhoes:
\[
PV_{old} = 187,771 + 18,619 = $206,390
\]
Present Value of Cash Flows for New Backhoes:
\[
PV_{new} = \sum_{t=1}^{8} \frac{43,900}{(1 + 0.08)^t} + \frac{90,000}{(1.08)^8}
\]
Similarly, calculating gives:
- Present Value of Net Cash Flows without Salvage: ≈ 9,807
- Present Value of Salvage Value: ≈ ,639
Total Present Value for New Backhoes:
\[
PV_{new} = 269,807 + 42,639 = $312,446
\]

3. Net Present Value Calculation

Next, we need to consider the initial investment required for both scenarios.
- Initial Investment for Old Backhoes: No new investment needed.
- Initial Investment for New Backhoes:
\[
Initial Investment = 5 \times 200,000 = $1,000,000
\]

NPV Calculation

NPV for Old Backhoes:
\[
NPV_{old} = PV_{old} - Initial Investment = 206,390 - 0 = $206,390
\]
NPV for New Backhoes:
\[
NPV_{new} = PV_{new} - Initial Investment = 312,446 - 1,000,000 = -$687,554
\]

4. Decision and Recommendations

The NPV of continuing with the old backhoes is positive at $206,390. Conversely, the NPV of purchasing the new backhoes is negative, indicating that not only would Shoals Corporation incur substantial costs that exceed the cash inflow generated by the newer models, but they would also experience significant loss from the high initial investment.
It is crucial to note that while the new models offer lower operating costs, comfort, improved efficiency, and maintenance benefits, these advantages do not outweigh the significant upfront cost when analyzed through a cash flow lens.

Conclusion

In conclusion, based on thorough cash flow analysis, Shoals Corporation should not invest in the new backhoes at this time. The company is better positioned to maintain its existing models for the next eight years, allowing for a more favorable cash flow situation. This analysis underscores the importance of not just considering improvements in technology or equipment but also grounding decisions in financial feasibility.

References

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This comprehensive report provides a succinct evaluation of Shoals Corporation’s capital investment evaluation that emphasizes the critical need for rigorous financial analysis in strategic decisions.