Role and Context

You are a financial analyst in the capital projects department of Multi-chem, a specialty chemicals producer of fire-control chemicals, additives, and pesticides based in Queensland. Currently, Multi-chem is small in scale, but embarking on a rapid expansion and modernization program. It is also expanding its range of products into dyes, rubber compounds, and water treatment chemicals. While Multi-chem has a large and expanding capital budget, it is currently considering which of two possible projects it should invest in, both of which would be used to manufacture furfural (an organic compound derived from agricultural by-products) and furfural-based derivatives to make resins, urethanes, and refining solvents over a 10-year operating period.

  

The first project, the Manila Plant, is a proposed new plant in the Philippines, about 30 km outside the capital. Multi-chem has been considering this expansion for a number of years and believes that the combination of low wages, looser environmental protection, and proximity to its emerging markets in SE Asia will makes this new plant an attractive addition to its existing facilities. Specifically, in 2021 the Manila Plant will require the purchase of land for $2.5 million, with development and construction building costs of $13.5 million, and plant and equipment of $6 million. Multi-chem will also need to spend on working capital each year. The change in net working capital is estimated to be 4% of sales every year during the life of the project (the exception being the last year of the project which reverses the sum of all previous cashflows due to working capital). Sales are estimated to be $48.6 million in 2022, the first year of production, increasing by 10% per annum after that. The cost of goods sold is 65% of sales. Fixed costs will be $11.5 million in 2022, increasing by 5% per year. Both buildings and plant/equipment will be depreciated straight line to zero over the 10-year project life. The buildings will have a salvage value of 20% of cost and the plant and equipment will have no salvage value. At the end of the project, Multi-chem will rehabilitate the site and sell the land for light industrial development for $18.1 million. The company tax rate in the Philippines is 25%.

The second project, the Cairns Plant, is a modification of an existing plant Multi-chem already owns in the city of the same name in north Queensland. The Cairns Plant has been idle for a number of years, but with renovation would be well suited to furfural production. If not used for the proposed project, Multi-chem will lease out the existing plant for $70,000 per year. The estimated development and construction building costs will be $15 million in 2021 alongside plant and equipment investment of $5 million. Multi-chem will again need to invest in working capital, thus the change in net working capital is estimated as 4% of sales every year (the exception being the last year of the project which reverses the sum of all previous cashflows due to working capital). Sales will be $45 million in 2022, increasing by 7.25% per annum thereafter. Given the relative geographic isolation of the plant and the stricter environmental controls given the proximity to the Great Barrier Reef, the cost of goods sold will be 75% of sales. Fixed costs will be $5 million in 2021, increasing by 5% per year. Both buildings and plant/equipment will again be depreciated straight line to zero over the 10-year project life. The buildings will have a salvage value of 30% of cost and the plant and equipment will have no salvage value. At the end of the project, the Townsville Plant will again revert to being idle awaiting potential future developments at no cost. The company tax rate in Australia is 30%.

Task

Provide a report to Multi-chem's CFO, Ms. Mary Miller, recommending which of these two mutually exclusive projects Multi-chem should invest in, if any. Your recommendation should be supported by appropriate calculations. Assume Multi-chem has a cost of capital of 12.5% for domestic projects and 16% for international projects.