Case study: Steel PLC

Your role

You are a recent graduate and newly appointed assistant to Emily Minrows, the Finance Director of Steel PLC. Your six-month probationary period is almost up and you are keen to make a good impression.

Required:

You have been tasked to produce a business report on the proposed capital investment project (see the following case study) for use by the Board of Directors in their upcoming meeting. The report should contain a discussion on the investment appraisal of the proposed capital investment project (you should use THREE investment appraisal techniques), financing alternatives for investments.

An investment appraisal report of the proposed capital investment project for the upcoming meeting of the Board of Directors. The report should include:

• An investment analysis of the proposed project discussed. You should project cash flows and use NPV, Discounted Payback Period and ARR as THREE investment appraisal techniques.

Present your view on the proposed investment decision with the arguments. You must include the advantages and drawbacks of the investment appraisal techniques used. You must show calculations in the annex and present the results in the report to strengthen your view.

Investment project related information

The management of Steel Plc is currently considering whether to establish a subsidiary company in Betulia, a country whose currency is the Bandl. The management of Steel Plc believes that the market for its products in Betulia is expanding and that by producing locally Steel Plc will be able to sell into what has traditionally been a very difficult export market.

The subsidiary company will require plant and equipment costing 6.4m Bandls and land and buildings costing 1.96m Bandls, to be paid at the start of the first year of production.

At the end of four years, the management of Steel Plc believes that competitors will have started production of similar products and remaining in the country will not be profitable. Therefore, Betulian investors will be offered all of Steels shares in the subsidiary at a price based upon the subsidiarys fourth years profit.

You should project cash flows and use NPV, Discounted Payback Period and ARR as THREE investment appraisal techniques based on the above case study. Please provide a 100% accurate answer.

Sales in Betulia are expected to be 6,500 units in the first year of production rising by 650 units in each of the next three years. The selling price of one unit will be 520 Bandls in the first year increasing by 15% per annum. Production costs, excluding depreciation, in Betulia are estimated to be 30% of sales value. The selling and distribution expenses of the subsidiary each year are expected to be equal to 20% of that years sales revenue.

The subsidiary will purchase specialised parts from local suppliers. These will be at the rate of 0.104 Bandls per unit of finished product, rising by 15% per annum.

Cost of capital-related information

Steel Plc has a cost of capital of 13% for similar projects undertaken.