You are the chief financial officer $($CFO$)$ of Tasman Pulp Mill Co$.($TPM$).$ Headquartered

in Launceston, Tasmania, TPM is an ASX$-$listed company that employs more than $1,200$

people across its diversified business units in Tasmania, where the overall unemployment rate

stands above $5\%,$ the highest among all states$/$territories in Australia. Mr$.$ David Hunt, the

current deputy CFO of TPM$,$ has just announced that he will retire in $6$ months after $20$ years

at TPM$.$ The chair of the recruitment committee of the board of directors at TPM asks you to

help find the next deputy CFO who will be able to assist the chief executive officer $($CEO$)$ and

you 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 deputy 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: 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 will pay $9\%$ 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 workers but at the same time is

less environmentally friendly.

$(3)$ The current pulp mill equipment has an annual output of $500,000$ air dried tonnes $($ADt$)$

of pulp which currently sells at $$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 has a book

value of $$28,000,000$ and another four years of life remaining with no salvage value. It can be

sold on the secondary market today for $$11,000,000.$ The new equipment costs $$75,000,000$

$($will be funded by bank loans$)$ and is expected to last five years with an estimated salvage

value of $$15,000,000.$ The new equipment will immediately reduce net working capital $($NWC$)$

by $$12,000,000.$

$(5)$ The current equipment requires annual fixed cash costs $($including overhead and

operating$)$ of $$41,500,000,$ while the new equipment requires $$37,800,000.$

$(6)$ Manufacturing pulp using the current equipment incurs the following costs $($per tonne$)$

in addition to the costs stated in $(5)$: labour $$33\mathrm{.}5,$ material $$36\mathrm{.}5,$ variable overhead $$14\mathrm{.}25,$

and fixed overhead $$16\mathrm{.}5.$ The corresponding figures for the new equipment are $$17\mathrm{.}45,$ $$30\mathrm{.}20,$

$$12\mathrm{.}55,$ and $$20\mathrm{.}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$)$ Based on the NPV rule, 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.

$($c$)$ What types of non$-$financial factors TPM must also consider when evaluating the new

technology.

Part II: The committee chair also asks you to prepare a list of questions which will be used

in the formal interview to test the candidates$$ theoretical understanding of project analysis and

capital budgeting. The Chair indicates that the number of questions should be no fewer than

five but no more than ten. The Chair further indicates that the majority on the interview panel

have no background in project analysis and capital budgeting; therefore they rely on the

answers prepared by you to conduct the interview and select the most suitable candidate for

the position of deputy CFO.