Bonnie Lim is a successful businesswoman living in a large Australian city with significant suburban areas. This city has distinct seasons, with cool and rainy winters, hot summers, and spring and autumn seasons that are warm and dry. In this city, there are significant public events in late October and early November. From the end of December to mid-January, with the sunny weather, many people are on holidays.

During Bonnies student years, she worked in a large department store and learned how important it is to give excellent customer service. She completed a degree in business studies and then took on a role in a large telecommunications company. During her eight years with this telco, she developed strong business skills and was seen as a successful professional. However, she also realised that she would very much like to run her own business and worked diligently to prepare herself to set up

a business.

After much thought, Bonnie decided to invest in a womens beauty salon in the suburb of Pleasant Hills. This salon provided both hairdressing services such as cutting and styling and colouring, and beauty therapy, in particular the provision of facials, manicures and pedicures, and massages. Although Bonnie herself did not have formal qualifications in the beauty therapy / hairdressing areas, she had always enjoyed availing herself of these services and over the years, through her discussions with the people providing service to her, had realised that, if she took on a business in the beauty industry, her customer service skills together with her strong business acumen could mean such a business would be a good fit for her. For this salon, she employed a full-time salon manager who also was a beauty therapist, but Bonnie did the administration and financial management herself.

In setting up this salon, Bonnie set up a company, Bonnie Beauty Pty. Ltd, with the salon trading as Bonnie Beauty Pleasant Hills. After years in the business, Bonnie has decided to take significant steps by investing significantly in the business. She is thinking of getting her company listed in the market.

As a soon-to-be graduate from the MBA Program from RMIT Vietnam, you are invited to provide advice on various issues in relation to managerial finance from which you have learnt from your Financial Analytics for Managerial Decisions. These issues cover many topics in managerial finance including time value of money, valuations of stocks and bonds, capital budgeting, risk and expected return and the cost of capital.

Question 1: Evaluating a significant investment project

The company is considering a proposal to lead the industry by manufacturing and providing a new and state-of-the-art equipment to provide services to customers. Bonnie considers that a new electric equipment, which is a product from this proposed investment project, would replace most of the existing equipment. A research break- through drawn from Bonnies years of experience gives Bonnie a two-year lead on its competitors. The project proposal is summarised in the following table:

Cash flows and present value of Bonnie Ltds proposed investment ($ thousands)

1. Capital expenditure: $10 million for new machine and $1,600,000 for a warehouse extension. The extension has been charged to the project at 50% of the full cost since only about half of the space is needed.

2. Research and development: $1,000,000 spent in 2021.

3. Working capital: initial investment in inventories.

4. Revenue: These figures assume sales of 2,000 equipment in 2023 and 3,000 per year from 2024 to 2026 at a price of $10,000 per unit.

5. Operating costs: These include all direct and indirect costs. Indirect costs (heat, light, power, fringe benefit, etc.) are assumed to be 100% of direct labour costs. Operating costs are forecasted to be $4,000 per unit.

6. Overhead: Allocated marketing and administrative costs, assumed to equal 10% of revenue.

7. Depreciation: Straight-line for 4 years.

8. Interest: Charged on capital expenditure and working capital at its current

   borrowing rate of 15%.

9. Income: Revenue less the sum of research and development, operating costs, overhead, depreciation, and interest.

10. Tax: 30% of income. Loss can be carried forward and deducted from taxable income in the future.

11. Net cash flow: Assumed equal to income less tax.

12. Net present value: Net cash flows are discounted at the companys cost of capital of 20%.

You are tasks to advise Bonnie and her executive team on the following issues:

a) Read the notes and the table carefully. Are all entries listed in the above table correct for application of the NPV method for capital budgeting decision? Have any relevant entries been omitted from the list? Explain why.

b)Prepare a cash-flow list that you believe is correct. Calculate the NPV, payback period, internal rate of return (IRR) and the profitability index for the project using your revised cash-flow calculation. Assume the acceptable payback period is 3 years, should the company undertake the proposed investment, based on each of the four different evaluation methods?

c)Assume Bonnie and the executive team has another new electric equipment which can be used to replace the existing equipment. However, this other machine has a life time of 6 years and hence, a relatively longer period of future cashflows than the project mentioned above. Which project will be more sensitive to changes in the required return? How would you analyse which project will be better in this case?

\begin{tabular}{|l|c|c|c|} \hline & 2022 & 2023 & 20242026 \\ \hline 1. Capital expenditure & 11,600 & & \\ \hline 2. Research and development & 1000 & & \\ \hline 3. Working capital & 400 & & \\ \hline 4. Revenue & & 20,000 & 30,000 \\ \hline 5. Operating costs & & 8,000 & 12,000 \\ \hline 6. Overhead & & 2,000 & 3,000 \\ \hline 7. Depreciation & & 2,900 & 2,900 \\ \hline 8. Interest & & 1,800 & 1,800 \\ \hline 9. Income & 1,000 & 5,300 & 10,300 \\ \hline 10. Tax & 0 & 1,290 & 3,090 \\ \hline 11. Net cash flows & 13,000 & 4,010 & 7,210 \\ \hline 12. Net present value =2,998 & & & \\ \hline \end{tabular}