Introduction

Flexipipe is a successful company supplying flexible pipes to a wide range of industries. Its success is based on a very innovative production process which allows the company to produce relatively small batches of flexible pipes at very competitive prices. This has given Flexipipe a significant competitive edge over most of its competitors whose batch set-up costs are higher and whose lead times are longer. Flexipipe's innovative process is partly automated and partly reliant on experienced managers and supervisors on the factory floor. These managers efficiently schedule jobs from different customers to achieve economies of scale and throughput times that profitably deliver high quality products and service to Flexipipe's customers.

New Software Package

A month ago, the Chief Executive Officer (CEO) at Flexipipe decided that he wanted to extend the automated part of the production process by purchasing a software package that promised even further benefits, including the automation of some of the decision-making tasks currently undertaken by the factory managers and supervisors. He had seen this package at a software exhibition and was so impressed that he placed an order immediately. He stated that the package was 'ahead of its time, and I have seen nothing else like it on the market'. The IT team suggests that this software package will endorse the savings of $1,200 monthly, for five years and will cost $60,000 presently. The CEO plans to utilize these savings by depositing them every month for the next five years into an account paying 12.4 percent interest.

This is the first time that the company is buying a software package for something that was not to be used in a standard application, such as payroll or accounts. Most other software applications in the company, such as the automated part of the current production process, have been developed in-house by a small programming team. The CEO felt that there was, on this occasion, insufficient time and money to develop a bespoke in-house solution. He accepted that there was no formal process for software package procurement 'but perhaps we can put one in place as this project progresses'.

Coopers.Co

This relaxed approach to procurement is not unusual at Flexipipe, where many of the purchasing decisions are taken unilaterally by senior managers. There is a small procurement section with two full-time administrators, but they only become involved once purchasing decisions have been made. It is felt that they are not technically proficient enough to get involved earlier in the purchasing lifecycle and, in any case, they are already very busy with purchase order administration and accounts payable. This approach to procurement has caused problems in the past. For example, the company had problems when a key supplier of raw materials Coopers.Co unexpectedly went out of business. This caused short-term production problems, although the CEO has now found an acceptable alternative supplier. Coopers.Co still owes Flexipipe $20,000. The companies have mutually agreed to a repayment schedule of $400 per month. Flexipipe will charge 2.1 percent per month interest on the overdue balance.

Financing Decisions

The abrupt decision by the CEO has put the Finance function in a dilemma as to which sources of finance should the company be raising funds from. The Finance director intends to raise the initial investment of $60,000 to buy the software package through the following three sources.

Share Scheme A

This scheme comprises of issuing ordinary shares such that no dividends will be paid over the next 8 years. The company will pay an $18 per share dividend in 9 years and will increase the dividend by 6 percent per year thereafter. The market requires a 10.4 percent return on similar shares.

Share Scheme B

This scheme comprises of issuing preference shares such that the issue will pay a $300 annual dividend in perpetuity, beginning 12 years from now. The market requires a 12 percent return on similar investments.

Debt Scheme C

Flexipipe can take out a $60,000, five-year loan at 13 percent. The loan agreement calls for the borrower to pay the interest on the loan balance each year and pay an Annuity for 5years, including the principal as well as interest.

Requirement

As part of the finance team, you are requested by the Finance Director to prepare a report for presentation in the upcoming meeting with the CEO. For that, you are REQUIRED to produce the following data for the report.

a)

Profitability Index of the purchase of Software package

b)

Discounted Payback Period of the purchase of Software package (On the basis of Savings)

The relevant discount factor for part (a) and (b) is 11%.

c)

The amount (in $) Flexipipe will get at the end of five years for investing the savings from the purchase of Software package

d)

The time period (in years) it will take Coopers.Co to settle its account of $20,000.

e)

The market share price Flexipipe can expect to sell ordinary shares at, under Share scheme A.

f)

The market share price Flexipipe can expect to sell preferene shares at, under Share scheme B.

g)

The total interest Flexipipe will be paying if it goes for the Debt scheme C.