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Madison plc is a public limited company, whose shares are quoted on the Alternative investment Market in London and has been operation in the UK for the past 10 years. Madison plc provides intellectual property to Oil and gas companies, HR consultants, Marketing companies, Tourist companies and investment property funds all over the UK. For the past 10 years, Madison plc has been a profit making firm as it has retained its previous clients, in addition to capturing an increasing share of the market. However, the Finance director of Madison has recently engaged your firm to help them source Finance for their expansion plans. New Software The current software product that Madison has been selling to companies is now deemed to be outdated and the company is looking to invest in a new product, and there are two proposals on offer. The details of these two proposals are outlined below. Madison Super Draft Figures '000 Year New software Cost Working Capital Sales Revenue Less: Component A (1,350) Component B (1,800) Overheads 0 5,500 400 1 2 3 4 5 9,800 550 5,500 700 6,500 850 7,700 1,000 8,750 (670) (800) (950) (1,100) (1,070) (1,500) (1,800) (2,100) (275) (325) (385) (438) (490) All of the above estimates have been prepared in terms of present day cost and prices. Assume that cash flows arise at the end of each period. In addition Revenues, overheads and working capital are expected to rise by 3% per year from year 1. The cost of component A and component B are expected to rise in line with inflation of 4% per year from year 1. The cost of senior technology officers, who have come from the US have not been taken into consideration in the forecast and are as follows: - Senior Technology Officer 1: Will be paid 200 per hour and expected number of hours for STO 1 are 1,470. The rate paid is expected to rise in line with inflation at 4% per year from year 2 and the number of hours is expected to reduce by 2% per year, every year from year 2 onwards. Senior Technology Officer 2: Will be paid 100 per hour and expected number of hours for STO 2 are 1, 700. The rate paid is expected to rise in line with inflation at 4% per year from year 2 and the number of hours is expected to reduce by 3% per year, every year from year 2 onwards. Depreciation is straight line over the life of the software, and the software is not expected to have any salvage value at the end of year 5. The company gets an annual capital allowance of 25%. Corporation tax is 33% and any tax benefit or tax expense is settled one year in arrears. Ignore depreciation when calculating corporation tax payable/receivable, but take the capital allowances into account. If Madison plc invests in Madison Super then the discount rate that would be required to assess the NPV would be 14%. Madison Platform: Madison Platform is the second of two proposals, the expected life of this software will also be 5 years and its working capital requirements, the cost of the new software, expected revenue, components cost and overheads are as follows: Madison Platform Draft Figures '000 Year New software Cost Working Capital Sales Revenue Less: Component A Component B (2,945) Overheads 0 8,500 500 1 2 3 4 5 12,006 653 6,200 806 7,564 959 9,001 1,112 10,531 (341) (1,320) (529) (1,875) (810) (2,250) (1, 053) (1,441) (2,723) (186) (227) (270) (316) (360) All of the above estimates have also been prepared in terms of present day costs and prices. Assume that the cash flows arise at the end of each period. In addition, you will need to take the costs of senior technology officers and capital allowances, inflation and the rise in the revenue, overheads and working capital into consideration, which are the same for the Madison Super. Corporation tax rate is 33%, and tax benefit or tax expense is steeled one year in arrears. If Madison plc invests in Madison platform then the discount rate that would be required to assess the NPV would be 13%. New Company Acquisition Madison plc is also considering to grow its operations across continental Europe, and at the moment there are two potential target companies that can help Madison plc in creating a presence in Europe, Puteaux digital France and Melia Portfolio Research Spain. For the purpose of this analysis, assume that the required investment funds will be provided by way of a capital loan from the parent entity or other sources of finance; however Madison plc is willing to acquire only one of the companies. The data for the past three years is given below: Required: Analyse the two Investment proposals by using NPV and provide recommendations. You should also briefly comment on other investment proposal techniques that Madison may use, and the limitations of using those techniques. If Madison plc has capital rationing problems where it has only 5.5 million of funds available for the new investment, suggest which software the company should opt for. Use IRR to support your decision and assume that the second rate of NPV as 10% for the Madison Super Software and 11% for the Madison Platform Software. Seminar 9 questions The essence of this seminar is to compare net profit, residual income and ROI performance measures Question 1: Marshall plc is a large conglomerate with headquarters in Sutton. They are involved in diverse business activities such as building, roofing and patios. They recently got a new contract to build a community centre in Sutton. The following information has been made available about the project: 1. The initial investment for the project is estimated to be 54. The project has a three year life-span and at the end of the project, the value will be nil. Depreciated is calculated on a straight line basis 2. The project is expected to generate annual revenues of 80m in year 1, 90m in year 2 and 100m in year 3. These values vary between +/5% 3. There is a yearly incremental cost of 50m in year 1, 60 in year 2, and 70m in year 3. These values varies between +/- 10% 4. The cost of capital is estimated to be 10%, but this may vary from 8% to 13% for the life of the project. 5. Assume that all cash flows with the exception of the initial investment take place at the end of each year 6. Use the write down value of the project at the start of each year to represent the value of the project for the year 7. Ignore taxation Required: a). Calculate the net profit, residual income and ROI for each year for the project b). Calculate the NPV for the project for i). The best outcome ii). The worst outcome Question 2: Cambridge | Chelmsford | Peterborough www.anglia.ac.uk The CP division of R plc had budgeted a net profit before tax of 3million per annum over the period of the foreseeable future, based on a net capital employed of 10,000. Plant replacement anticipated over this period is expected to be approximately equal to the annual depreciation each year. These figures compare well with the organisation's required rate of return of 20% before tax. CPs management is currently considering a substantial expansion of its manufacturing capacity to cope with the forecast demands of a new customer. The customer is prepared to offer a five-year contract providing CP with annual sales of 2million. In order to meet this contract, a total additional capital outlay of 2million is envisaged being 1.5million of new fixed assets plus 0.5million of working capital a year. Operating costs on the contract are estimated to be 1.35million per annum, excluding depreciation. This is considered to be a low risk venture as the contract would be firm for five years and the manufacturing processes are well understood within CP. Required: Calculate the impact of accepting the contract on the CP divisional Return on Capital Employed (ROCE) and residual Income (RI), indicating whether it would be attractive to CP's management. Cambridge | Chelmsford | Peterborough www.anglia.ac.uk