FIN 4801 Capital budgeting CASE Autonomous Vehicles Ltd. (Auto V for short) is a listed company located in Berea. The company develops self-driving enabling, machine learning, software based on the OpenCV package. AutoV usually develops and customises software for clients which use them in their autonomous vehicle projects and have done so for prototype cars, in production imaging drones and traffic management systems. Currently however, the company is conducting planning to develop its first physical product leveraging its experience in the field. The company is conducting planning to produce and market an Al driven imaging system for municipalities that will use imaging data from its maintenance vehicles to spot and log location data of potholes. The premise is that this data will then be fed to the road maintenance contractors responsible in the area when the vehicle reaches an area where it can connect to a Wi-Fi hotspot The imaging system will consist of a bracket that will be fitted to the bottom of the vehicle, a wiring loom to power it, a micro- computer, a camera module, a light and a spring-steel box to protect the assembly. All components will be bought and assembled, however, the company will require the correct work-desks, loose tools and materials and sundry glue and fasteners to assemble the final product. The assembly line will be located in the current office space the company occupies but will take up negligible space as it is really only two anti-static rubberised desks and high chairs. A compilation of expected costs are contained in the following spreadsheet: F3 fr A C 1 h 2 3 Chairs Desks Tools B D Installation cost Cost Write-off period RO R 20 000 6 R 1 000 R 30 000 6 RO R6 000 1 4 5 Costs Figure 1: Costs and depreciable lives As can be seen in Figure 1, the accountant already provided the correct and relevant write off periods for each capital item. The team has compiled a spreadsheet with the following expected costs per item required to manufacture a unit: B 1 2 Computer 3 Camera module 4 LED Light 5 Case 6 Bracket 7 Wiring loom 8 Costs R 800 R 250 R 50 R 2 000 R 1 000 R 200 PU_Costs The company will also buy R3000 worth of screws and glue for the assembly of the smart imaging devices. The screws and glue can be construed as working capital, but it would not be recouped at the end of the project due to the specialised nature of the project. After initial discussions with the local municipality, the founder of the company expects to sell the devices for R8 000 per unit, but that on the initial production run, orders would likely be limited due to the municipal manager indicating that they would first need to evaluate the technology. The team has decided to only market it to its local municipality for now and only to undertake marketing in other areas until it is confident that the product works well in real- world conditions. The team further expects that there will be setback in the first production run and is realistic in its expectations, knowing that lessons learnt from the first run, will be incorporated in the next version which may be critical to the long term success of the product. Due to this expectation, the company has decided to continue with the project even if it makes a loss which the company can absorb, which is agreed upon to be a maximum of R20 000. At the moment, the company is financed by R500 000 in equity and R400 000 of bank loans. The project will be partially financed by a loan of R30 000 from a bank at a rate of 22% per annum, with the bank indicating that the rate is based on the current risk profile of the company, while the remainder will be financed out of retained earnings. The company has a beta of 2.00 associated with its shares, the risk free rate is 7% and the market risk premium is 6%. The applicable corporate tax rate is 28%. It is expected that the project will continue for 3 years. The price of the product sold will be adjusted for inflation by 5% per annum (the prices provided earlier are in current{Y0} terms). At the end of the project, the chairs, desk and tools are all expected to be sold for 50% of their respective purchase prices. After a consultation with the development team, the founder of the company expects to be able to deliver between 12 and 24 systems per year with the following probability distribution being applicable: a 50% chance that 12 units will be manufactured, a 30% chance that 18 units will be manufactured and a 20% chance that 24 units will be manufactured. The municipality has agreed to purchase all systems that can be delivered over the three year period One of the managers indicated that she is of the opinion that they should adjust the discount rate for the inherent risk in the project. She proposes that if the CV of sales is in excess of 0.4, the discount rate should be multiplied by 1.5. Her staffing argument is that there are other viable projects for software development, and on those projects, a multiplier was used. Others objected to this idea due to the strategic value of the project, however, it was agreed that the project should be evaluated with and without the addition of a possible risk adjustment, if necessary The management of the company is deciding whether it should go ahead with the project based on its financial feasibility. The company however only has an outside accountant that provides ad-hoc services to the company. You have been hired as an intern in the company and upon learning of your education, the founder of the company tasked you with coming up with a clear, tractable analysis and evaluation of the project's feasibility including a statistical analysis of the possible variation in sales and the expected influence on the profitability of the project FIN 4801 Capital budgeting CASE Autonomous Vehicles Ltd. (Auto V for short) is a listed company located in Berea. The company develops self-driving enabling, machine learning, software based on the OpenCV package. AutoV usually develops and customises software for clients which use them in their autonomous vehicle projects and have done so for prototype cars, in production imaging drones and traffic management systems. Currently however, the company is conducting planning to develop its first physical product leveraging its experience in the field. The company is conducting planning to produce and market an Al driven imaging system for municipalities that will use imaging data from its maintenance vehicles to spot and log location data of potholes. The premise is that this data will then be fed to the road maintenance contractors responsible in the area when the vehicle reaches an area where it can connect to a Wi-Fi hotspot The imaging system will consist of a bracket that will be fitted to the bottom of the vehicle, a wiring loom to power it, a micro- computer, a camera module, a light and a spring-steel box to protect the assembly. All components will be bought and assembled, however, the company will require the correct work-desks, loose tools and materials and sundry glue and fasteners to assemble the final product. The assembly line will be located in the current office space the company occupies but will take up negligible space as it is really only two anti-static rubberised desks and high chairs. A compilation of expected costs are contained in the following spreadsheet: F3 fr A C 1 h 2 3 Chairs Desks Tools B D Installation cost Cost Write-off period RO R 20 000 6 R 1 000 R 30 000 6 RO R6 000 1 4 5 Costs Figure 1: Costs and depreciable lives As can be seen in Figure 1, the accountant already provided the correct and relevant write off periods for each capital item. The team has compiled a spreadsheet with the following expected costs per item required to manufacture a unit: B 1 2 Computer 3 Camera module 4 LED Light 5 Case 6 Bracket 7 Wiring loom 8 Costs R 800 R 250 R 50 R 2 000 R 1 000 R 200 PU_Costs The company will also buy R3000 worth of screws and glue for the assembly of the smart imaging devices. The screws and glue can be construed as working capital, but it would not be recouped at the end of the project due to the specialised nature of the project. After initial discussions with the local municipality, the founder of the company expects to sell the devices for R8 000 per unit, but that on the initial production run, orders would likely be limited due to the municipal manager indicating that they would first need to evaluate the technology. The team has decided to only market it to its local municipality for now and only to undertake marketing in other areas until it is confident that the product works well in real- world conditions. The team further expects that there will be setback in the first production run and is realistic in its expectations, knowing that lessons learnt from the first run, will be incorporated in the next version which may be critical to the long term success of the product. Due to this expectation, the company has decided to continue with the project even if it makes a loss which the company can absorb, which is agreed upon to be a maximum of R20 000. At the moment, the company is financed by R500 000 in equity and R400 000 of bank loans. The project will be partially financed by a loan of R30 000 from a bank at a rate of 22% per annum, with the bank indicating that the rate is based on the current risk profile of the company, while the remainder will be financed out of retained earnings. The company has a beta of 2.00 associated with its shares, the risk free rate is 7% and the market risk premium is 6%. The applicable corporate tax rate is 28%. It is expected that the project will continue for 3 years. The price of the product sold will be adjusted for inflation by 5% per annum (the prices provided earlier are in current{Y0} terms). At the end of the project, the chairs, desk and tools are all expected to be sold for 50% of their respective purchase prices. After a consultation with the development team, the founder of the company expects to be able to deliver between 12 and 24 systems per year with the following probability distribution being applicable: a 50% chance that 12 units will be manufactured, a 30% chance that 18 units will be manufactured and a 20% chance that 24 units will be manufactured. The municipality has agreed to purchase all systems that can be delivered over the three year period One of the managers indicated that she is of the opinion that they should adjust the discount rate for the inherent risk in the project. She proposes that if the CV of sales is in excess of 0.4, the discount rate should be multiplied by 1.5. Her staffing argument is that there are other viable projects for software development, and on those projects, a multiplier was used. Others objected to this idea due to the strategic value of the project, however, it was agreed that the project should be evaluated with and without the addition of a possible risk adjustment, if necessary The management of the company is deciding whether it should go ahead with the project based on its financial feasibility. The company however only has an outside accountant that provides ad-hoc services to the company. You have been hired as an intern in the company and upon learning of your education, the founder of the company tasked you with coming up with a clear, tractable analysis and evaluation of the project's feasibility including a statistical analysis of the possible variation in sales and the expected influence on the profitability of the project