Purchase Price Useful Life (years) Depreciation (reducing balance method) Salvage value at the end of useful life Annual interest expense Annual scrap revenue Annual operating costs Variable overheads -Salaries Marketing 4/5 LCC HCC $400,000 $480,000 4 6 40% pa 30% pa $80,000 $48,000 $48,000 $48.000 $450,000 $600,000 $50,000 $150,000 $80,000 $110,000 $45,000 $60,000 The calculation for annual operating costs includes the following items F6 FT Fe % A 5 6 B DELL F9 F10 F11 F12 * Priser T Insert Delete Pyip & 7 + 8 ( 9 Backspace Num Loc a) Variable overheads are direct operating expenses incurred in the production of the fine or rough scrap. b) Salaries represent the costs of employing two new machine operators at a salary of $40,000 per annum cach. For the HCC machine, the company will only need to employ a new machine operator and the second, who eams $70,000 per annum, will be transferred from the axle assembly plant. The second operator from the main plant would otherwise have been made redundant with a redundancy payment of $50,000. c) The marketing cost is based on the standard allocation of the new investment towands group advertising expenses, which is 10% of annual revenue. It has been estimated that the additional group advertising required to promote the sales of fine or rough scrap is only $40,000 per year. The accrentant, Mr. Smith pointed out to you that the sevense figures do not take into consideration the scrap sales that XYZ would generate negandles of whether the company bought either machine. He has estimated that the cument unprocessed scrap would generate a net income of $50,000 per year Production facilities for the steel scrap would be at sp in an used section of XYZ Limited main plant. The section of the plant where the stel soap production would occur hos bom used for several years and comcqntly had suffered some deterioration. Last year, as part of a stine facilities inprovement program XYZ Limited spa $80,000 archable ther DELL FB F7 FB F9 F10 F11 F12 C P 90 Preser T Insert Delete Pylip % A & * ( 5 6 7 8 9 01 + Nym Backspace Lock T Y U I P 5/5 bought either machine. He has estimated that the current unprocessed scrap would generate a net income of $50,000 per year. Production facilities for the steel scrap would be set up in an unused section of XYZ Limited main plant. The section of the plant where the steel scrap production would occur has been unused for several years and consequently had suffered some deterioration. Last year, as part of a routine facilities improvement program, XYZ Limited spent $80,000 to rehabilitate that section of the main plant. Mr. Smith believes this outlay, which has already been paid and expensed for tax purposes, should be charged to the steel scrap project. His contention is that if the rehabilitation had not taken place, the firm would have to spend $50,000 to make the site suitable for the steel scrap project. As the section of the plant has been rehabilitated, it could Setch a rental income of $40,000 per year. The company's nominal cost of capital is 15 percent per annum. Assume that the company is subject to 30% corporate tes and that the tax is paid at end of the same year (ie not the following year DELL F7 FB F9 P F10 F11 F12 Priser T Insert Delete %6 & 5 6 7 8 69 ) 0 Backspace QUESTIONS 1. 2. 3. repare cash flow tables which incorporates taxes and includes initial investment, operating, and terminal cash flows) for each chip crusher Compute net present value, payback period, and internal rate of retum to recommend either lower-cost chip crusher (C) or higher-cost chip crusher (HCC). [30 marks] Clearly state the assumptions with justification, undertake research to identify the qualitative factors considered in recommending LCC or HCC? 4 [10 marks] It is necessary to check if the project made financial sense before it is accepted. Therefore, i) Conduct a sensitivity analysis of NPVs to change in the annual revenue and operating costs individually. Assume each of these variables can deviate from its estimated value by plus or minus 15% (Hint: Provide the answers to this question even if you decide to reject the project] i) Adjust for the effect of inflation on both machines. For simplicity, assume no other cash flows apart from the sales revenues and operating costs are affected. For both chip crashers, the sales revenues are expected to increme by the 5 percent rate beginning after Year L. However, the annual operating ons are expected to increase by only 3 pesest anually. [30] Consider all information given in the case study and the results derived in Questions I to 3. Advise the executive commitee on whether they should invest in an LCC or HCC Discus the seasons for your recommendation and the inses the XYZ Company nods to take into account, gives this advice. DELL [10] F7 FB F9 F10 F11 F12 PrtSer Insert Delete Pyp A TO % A & 54 6 7 8* ( + Hum Backspace 9 = T Y U P } 1 CASE STUDY XYZ Company Please read the case of XYZ Company before starting this assignment. Your task as a financial analyst is to prepare a project evaluation report to executive committee of XYZ Company indicating whether the firm should accept or reject the new project. Your report should include the answers to the following Questions 1 to 4. It is important to list your assumptions in applying the project evaluation methods, and show clearly the workings in deriving your results. Your assignment will be graded on presentation, understanding of the issues, critical analysis, logical explanation, and accuracy of calculations in solving the problems. The mark allocations for individual questions (including 20 marks for presentation, writing and professional communication) will total to 100 marks and will be scaled to produce a mark consistent with 25% weighting in the unit assessment. QUESTIONS 1. 2. 3. 4. Prepare cash flow tables (which incorporates taxes and includes initial investment, operating, and terminal cash flows) for each chip crusher. Compute net present value, payback period, and internal rate of return to recommend either lower-cost chip crusher (LCC) or higher-cost chip crusher (HCC). [30 marks] Clearly state the assumptions with justification, undertake research to identify the qualitative factors considered in recommending LCC or HCC? [10 marks] It is necessary to check if the project made financial sense before it is accepted. Therefore, i) Conduct a sensitivity analysis of NPVs to change in the annual revenue and operating costs individually. Assume each of these variables can deviate from its estimated value by plus or minus 15%. [Hint: Provide the answers to this question even if you decide to reject the project.] ii) Adjust for the effect of inflation on both machines. For simplicity, assume no other cash flows apart from the sales revenues and operating costs are affected. For both chip crushers, the sales revenues are expected to increase by the 5 percent rate beginning after Year 1. However, the annual operating costs are expected to increase by only 3 percent annually. [30 marks] Consider all information given in the case study and the results derived in Questions 1 to 3. Advise the executive committee on whether they should invest in an LCC or HCC. Discuss the reasons for your recommendation and the issues the XYZ Company needs to take into account, given this advice. [10 marks] Case in Finance XYZ Company XYZ Limited is a manufacturer of transmissions and axles used in the harvesting equipment of the agricultural industry. The manufacturing process is quite extensive, resulting in a vast amount of bulky steel scrap. The unprocessed steel scrap is sold as a by-product of the manufacturing operation to various firms involved in the recycling process. The executive committee is currently evaluating whether to process the scrap into different grades and types of usable steel. Using various models of chip crushers, the scrap can be ground and compressed into either rough or fine scrap. The fine scrap would fetch a higher market price than the rough scrap. XYZ Limited has to decide whether to invest in the higher-cost chip crusher (HCC) to produce fine scrap or the lower-cost chip crusher (LCC) to produce rough scrap. As a financial analyst of the company, you have gathered relevant purchase prices and operating costs of the two chip crushers from the supplier of the chip crushers and the marketing and production staff. The key estimates of financial data for the two machines are given below: Purchase Price Useful Life (years) Depreciation (reducing balance method) Salvage value at the end of useful life Annual interest expense Annual scrap revenue LCC HCC $400,000 4 $480,000 6 40% pa 30% p.a. $80,000 $48,000 $48,000 $48,000 $450,000 $600,000 Annual operating costs: - Variable overheads -Salaries Marketing $50,000 $150,000 $80,000 $110,000 $45,000 $60,000 The calculation for annual operating costs includes the following items: a) Variable overheads are direct operating expenses incurred in the production of the fine or rough scrap. b) Salaries represent the costs of employing two new machine operators at a salary of $40,000 per annum each. For the HCC machine, the company will only need to employ a new machine operator and the second, who earns $70,000 per annum, will be transferred from the axle assembly plant. The second operator from the main plant would otherwise have been made redundant with a redundancy payment of $50,000. c) The marketing cost is based on the standard allocation of the new investment towards group advertising expenses, which is 10% of annual revenue. It has been estimated that the additional group advertising required to promote the sales of fine or rough scrap is only $40,000 per year. The accountant, Mr. Smith pointed out to you that the revenue figures do not take into consideration the scrap sales that XYZ would generate regardless of whether the company bought either machine. He has estimated that the current unprocessed scrap would generate a net income of $50,000 per year. Production facilities for the steel scrap would be set up in an unused section of XYZ Limited main plant. The section of the plant where the steel scrap production would occur has been unused for several years and consequently had suffered some deterioration. Last year, as part of a routine facilities improvement program, XYZ Limited spent $80,000 to rehabilitate that section of the main plant. Mr. Smith believes this outlay, which has already been paid and expensed for tax purposes, should be charged to the steel scrap project. His contention is that if the rehabilitation had not taken place, the firm would have to spend $50,000 to make the site suitable for the steel scrap project. As the section of the plant has been rehabilitated, it could fetch a rental income of $40,000 per year. The company's nominal cost of capital is 15 percent per annum. Assume that the company is subject to 30% corporate tax and that the tax is paid at end of the same year (i.e. not the following year).