You are a senior recruiter at Best People, a recruitment agency.Mr. David Smith, the chief financial officer (CFO) of Tasman Pulp Mill Co. (TPM), has just announced that he will retire in 6 months after 25 years at TPM. A long-term client of Best People, TPM is a Launceston-headquartered, ASX-listed company that employs more than 1200 people across its diversified business units in Tasmania, where the overall unemployment rate is above 7.5%. The chair of the recruitment committee of the board of directors at TPM asks you to help find the next CFO who will be able to assist the chief executive officer (CEO) to continue the success and growth that TPM has seen over the last two decades or so.

You indicate to the committee chair that, because TPM continues to expand its operations via either acquiring other businesses or upgrading current facilities, it is critically important the incoming CFO has thorough understanding of project analysis and capital budgeting. You also suggest that the best way to test the candidates' knowledge and practical skills is to ask the candidates to analyze a simulated case in addition to the usual formal interview.

Part I (8 marks):The committee chair agrees with you and asks you to come up with a mock case. The information listed below will be given to the candidates.

(1) TPM has an after tax cost of capital of 12%; it willpay 9% on any new bank borrowing;the current tax rate is 30%.

(2) A new manufacturing technology has just become available. Adopting this new technology requires TPM to upgrade its manufacturing equipment. Compared to the existing technology,the new technology is faster and requires fewer workersbut at the same time isless environmentally friendly.

(3) Thecurrent pulp mill equipment has an annual output of 500,000 air dried tonnes (ADt)of pulp which currently sellsat $124 per tonne. In contrast,the new equipment will have an annual output of 600,000 ADt of pulp.

(4) The current equipment was purchased three years ago for $49,000,000. It hasa book value of $28,000,000andanother four years of life remainingwith no salvage value. It can besold on the secondary market today for $11,000,000.The new equipment costs $75,000,000(will be fully funded by bank loans) and is expected tolast five yearswith an estimatedsalvage value of $15,000,000. The new equipment will immediatelyreduce net working capital (NWC) by $12,000,000.

(5)The current equipment requires annual fixed cash costs(including overhead and operating) of $4,150,000, while thenew equipment requires $3,780,000.

(6) Manufacturing pulp using the current equipment incurs the following costs (per tonne) in addition to the costs stated in (5): labour $33.5, material $36.5, variable overhead $14.25, and fixed overhead $16.5. The corresponding figures for the new equipment are $17.45, $30.20, $12.55, and $20.25, respectively.

All candidates are required to answer the following questions. The committee chair asks you to prepare the correct solutions so the answers by the candidates can be checked.

(a)From the perspective of capital budgeting, should TPM upgrade to the new technology or continue to operate using its current equipment?

(b) Conduct risk evaluations (using the sensitivity analysis) of adopting the new technology by considering the following factors: output using the new technology may be overestimated; the reduction in NWC may be overestimated; due to continuous development in the industry,the equipment may worth less than $15,000,000 in five years; the labour cost per tonne may be underestimated.