Let us return to the cement Practical Case Study from Chapter 7. The executives of the cement company have decided to go ahead with the investment appraisal and have retained you for the more detailed analysis.

In any capital budgeting investigation, you need an estimate of future net cash flows, future growth rates and appropriate discount rates. We will leave a detailed discussion of discount rates until later in the text.

Cash Flows In the first stage of the consultancy, you were informed that the investment will be TSh5 billion and operating revenues are expected to increase by TSh800 million per year. That was just an estimate and, after several interviews, you have come up with a more detailed cash flow forecast. First, the TSh5 billion investment is made up of three components. The cement company will need to purchase the land for TSh2 billion, and spend TSh2 billion on property, plant and machinery. The other TSh1 billion will be paid out in salaries, wages and other cash expenses every year.

You need to find out about taxation and depreciation in Tanzania. You know that the country follows International Accounting Standards and so all the material in this textbook is appropriate. However, you need the actual depreciation rules, which differ in every country. The first place you should look is the Tanzanian Ministry of Finance website (www.mof.go.tz/mofdocs/revenue/incometax/start.htm). At this site you will find the appropriate corporate tax rate and all depreciation rates for your company.

Operating revenues are based on the expected total demand for cement and the current cement price of TSh90,000 per tonne. If the expansion goes ahead, the company expects to sell an additional 20,000 tonnes of cement at a constant gross profit margin of 44 per cent. However, these figures may change depending on economic conditions and changing costs. The company expects to run the new operations indefinitely.

Growth Rates In the previous chapter, you spent a lot of time thinking about the factors that drive growth rates. Now, with this information, you should consider several growth rate scenarios for your company. You should also be able to defend your assumptions.

Discount Rates Similarly, you should consider the information you have been given by the experts as well as all other information available in the markets to come up with several discount rate scenarios. You should be able to defend your choices here as well.

Activities a Carry out a full capital budgeting analysis on the above problem using one or more techniques you feel are appropriate here.

b As with any real-life capital budgeting analysis, the leeway in assumptions can really make your analysis difficult. Carry out a full sensitivity analysis on the project based on your own private analysis.

c Clearly state and explain all assumptions in your analysis.

d Discuss some factors, costs, inputs or assumptions that have not appeared in the analysis, and suggest ways in which you can gather this information for an extension of the analysis.

e Write a consultancy report on the analysis.

Many students will be put off by the complexity of this analysis but the practice of actually working with real and often poor data is one of the best skills you can develop. Corporate finance consultants get paid very handsomely for their work and this is primarily because the investment decision is one of the most important facing a firm. If managers get it right, a good investment can add millions to firm value. Get it wrong and the firm can go bankrupt!