Silk Road Textiles Incorporation (Investment in new equipment) Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

What yearly cash flows are relevant for this investment decision?

There are many cash inflows and outflows movements in the project appraisal and some of the items are non-cash such as depreciation that is also relevant for project appraisal. The list of those items is given below.

The first item is the initial capital investment of $16 million that will take place in 2015. The investment is related to the purchase of new equipment and its installation cost that are directly related to the equipment.

The second item is a capital investment that will take place in 2016. The second initial investment is also related to the main investment and it is a simple addition to the first initial investment but the timing of capital expenditure is different.

There is a first operating cost saving that is about to take place in 2016. The cost saving amounts to $2 million, the saving takes place due to advanced equipment that has increased the efficiency of the productivity as well as has saved some operating cost. The operating costs are usually direct labor cost, utility expenditure, rental expense of the building and many more.

The second operating cost will flow to the entity from 2017 to the end of the investment appraisal period. The operating cost saving amounts to $3.5 million for the period specified above.

There are cash outflows of tax due to cost savings, the cost saving increases the profits and the ultimate effect is on profitability. The increase in tax expense is considered as a cash outflow for free cash flow purpose.

In excess to cost saving, the incremental revenues will flow to the entity the first cash inflow will occur in 2016 and it amounts to $4 million. The inflow has occurred due to the increase in efficiency of the company and its production capacity that has given an opportunity to Silk Road to sell more units of its textile products.

The incremental revenues from 2017 on wards till the investment tenor are amounting to $10 million. The reason behind such changes is that in the first year of operations the new equipment may not give the company an opportunity to increase its production up to the maximum level of the new equipment therefore the cash flows in the first year are lower than that next years.

The cost of goods sold is another relevant cash outflow, the revenues cannot be generated without any costs related to those revenues. The cost of sales is 75% of the total revenues. The cost seems to be the direct cost because it has a direct relationship with the revenues. The cost of sales is material cost, labor cost and many other costs that are directly attributable to revenues.

Selling and administration cost are 5% of the sales that represents another cash outflow due to increase in its sales. The cost is related to the commissions of sales agents and other administrative costs that are attributable to incremental revenues.

The increase in revenues does need some working capital to finance the incremental revenues. The increase in working capital is amounting to 10% of the revenues. The working capital is directly attributable to revenues because the working capital consists of cash, receivables, payables and inventory. The incremental revenues require putting extra working capital to finance the increased working capital requirements.

The injection of working capital can be withdrawn at the end of the investment tenor. The injected amount can be withdrawn as at the end of the period all receivable are paid off due to the closure of operations and inventory is converted to the finished goods therefore the injected capital is withdrawn at the end. In this case capital withdrawn is amounting to $5.4 million.

Silk Road Textiles Incorporation (Investment in new equipment) Case Solution

Another cash inflow is the tax saving due to the net loss in the investment tenor due to depreciation impact on the income statement. There is a net loss in tax and accounting due to new equipment, capital expenditure and other costs related to the revenues.

The last item is the scrap value of the equipment that is $1.8 million. This is a cash inflow that will flow to Silk at the end of the investment tenor..............

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