Fonderia Ditorino Case Study

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Legal Factors (Grievances): The molding procedure Fonderia di Torino currently uses (mixing sand and adhesive under heat) is relatively labor intensive and demands heavy lifting from some workers. As a result, medical claims for back injuries in the molding shop doubled since 1998 as the mix of Fonderia di Torino’s casting products shifted towards heavy items. With the greater risk of injury associated with using the current machine, the likelihood of lawsuits or grievances could rise, resulting in more payouts in terms of compensation payments. Having higher work accidents would also reflect poorly on the perceived ethical standards of the company and management; potentially affecting share value.

In the case of purchasing the new machine, you would have to lay off and/or reassign 24 employees. Given the company’s current unionized position, this would incur some difficulties. Assigning 24 new janitors to the company could be an option but is not a realistic approach. A prepared set of severance packages could be in order. though it would be hard to calculate, this outcome could affect the overall cost of taking the new machine and in theory, should be taken into consideration.

Economical conditions: The current outlook for future economic conditions in Europe are increasingly negative.. Increasing productive capacity just before a recession could put a lot of these resources in an idle state, creating a certain level of opportunity cost. As indicated, the overall state of the economy could also affect inflation and in turn, overall company performance.

Quantitative analysis

Fonderia Di Torino must evaluate the effectiveness of cost savings realized by the Vulcan-Mold-Maker in order to determine whether or not to invest in this new machine. If the operational costs realized by the Vulcan-Mold-Maker over its useful life are greater than the costs incurred by the semi-automated machines over their useful-life, then the firm should not invest in the project. If the Vulcan costs less to operate than the old machines among other factors which will be discussed, then they should invest in it. The firm must also evaluate other effects on the firm that arise if they chose to purchase the machine such as their labor force and productivity. We conducted a complete net present value and sensitivity analysis with regards to both machines to determine what actions the firm should take.

Assumptions in our inputs - Data and Calculations

In order to calculate and analyze the potential cost savings generated by the new machine, we had to make certain assumptions to guide us in our analysis and establish accurate measures. All of the data used for calculations are summarized in Appendix 2.

Some notable assumptions are that you maximize the cheaper loan (33% of the investment at 6.8% p.a) and finance the balance of the machine with the more expensive loan (67% of the investment at 7% p.a). We also assumed that the weight of your firm's debt and equity remain the same. With regards to the WACC we calculated the cost of equity based on the data provided by your firm (Appendix 6); using a provided beta of 1.25, risk-free investment rate in euro-denominated bonds of 5.3% and a risk premium of 6%. Using the Capital Asset Pricing Model, we determined the cost of equity to be 12.80%. Our cost of debt was calculated by taking a weighted average of the rates of the loans provided for financing, calculated to be 6.93%. The following is our WACC calculation.

This metric is extremely important because it will be used as a discount rate applied to the costs incurred from each machine. In our case we actually calculated two different WACCs, one for the old machine one and one from the new machine. (Appendix 1)

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The old machine will not be financed by any new loans, thus WACC will be based on their current cost of debt which is 6.8% (Appendix 5). Resulting in a WACC of 9.86%.

On the other hand, the new machine’s WACC will be a weighted average of their loans which result in a 6.93% cost of debt. Therefore, adjusting the WACC to 9.88%.

We also assumed that the new machine would be depreciated at 20%, amortized over its useful life of 8 years. Using this method, you will be paying less taxes initially but these charges will gradually increase as less and less depreciation is accounted for but this method does create salvage value for the asset. In addition, we also assumed that the new machine would be sold for its salvage value at the end of its useful life, providing cash inflow.

NPV Results Analysis

Please refer to Appendix 3 for our discounted cash flow analysis.

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These results come from the difference in NPV between the new machine and the old machine with variable inflation and a variable layoff percentage. (Appendix 4)

We built a sensitivity analysis table regarding your layoff policies and economic inflation to capture all the risks and effects they can have on the NPV of the project. The idea is to maximize the positive effects of how many employees you can lay-off in order to maintain positive cost savings. The outcomes of these calculations show positive cost savings or NPV the greater the inflation rate. Furthermore, to stay cost-effective you should lay-off 75% of the workforce and retain six workers who will transition to janitorial positions. If you were to maximize these results you would have to lay-off 100% of the workforce but this could cause internal and legal issues as mentioned earlier.

Moreover, since the European economy is expected to slow down over the next few years (Appendix 7), we suggest and forecast periods of disinflation where inflations level will not be as high as 3%. Our outlook suggests a 1% to 2% inflation rate for the next few years. We believe that this approach; a more realistic approach, will help you in your decision making.

Considering our suggestion of laying-off 75% of the current workforce and expecting 1%-2% inflation, you can expect cost savings between €45,388 to €63,943 by investing in the Vulcan-Mold-Maker.

Equivalent Annual Annuity (EAA) Analysis

We also determined the Equivalent Annual Annuity for another the projects. This approach considers two projects with unequal lives and calculates the constant annual cost of each project over its useful life as if it were an annuity. When using this method, the project with the higher EAA should be chosen but in our case we are considering