You have just received the following memo from the company's Chief Executive Officer George Lazyboy and have decided you need to prepare thoroughly for any questions that might arise from your colleagues. On first glance you are a little concerned with some of the calculations and feel you might have to talk briefly with Mr Lazyboy before the meeting as well. | (2 marks) After graduating with a B.Com (Finance) from the University of Auckland you have been employed by a company called PlastiTubes Ltd., as a project finance manager. PlastiTubes is based in Auckland's industrial area of Penrose and manufactures a variety of Fibre Reinforced Polymer (FRP) pipes and containers used for transporting and storing corrosive liquids. PlastiTubes supplies customers in New Zealand and Australasia who are mainly involved in the petrochemical and wastewater (sewage) treatment industries Their main product, FRP pipe, has an exceptional strength to weight ratio, and weight for weight is stronger than steel. The pipes also have good shock and impact resistance and excellent flow characteristics as a smooth glass-like interior finish reduces material build-up and improves fluid transmision transmission PlastiTubes is a medium sized company listed on the NZX and has 20 million shares on issue - the current share price is $2.40. In addition, PlastiTubes issued 5 million preference shares three years ago. These preference shares have a $1 face value and a fixed dividend of 12%p.a. The preference shares are currently trading at $1.50 each. The company's equity beta (B) is 1.20, the New Zealand market risk premium is estimated at 6.0% p.a., the yield on 10-year New Zealand government bonds is 2.50% p.a., and the company tax rate is 28%. The company's long-term debt consists entirely of 15,000 10-year bonds issued exactly five years ago (these are listed on NZDX). Each bond has a face value of $1,000 and an annual coupon rate of 8.5% (paid semi-annually). The bonds are currently trading at a yield to maturity of 5.23% p.a. Memo To: All Finance Staff From: George Lazybay - CEO Date: 29 Jamary 2021 Re: Capital Expenditure As you know, Plastilubes evaluates Capital Expenditure decisions using discounted cash- flows. The discount, or hurdle, rate is our company's weighted average cost of capital. This memo is to clarify our company's long-standite policy regarding hurdle rates for these investment decisions. Plastilules is considering an investment in a new FRP Filament Winder that will improve the quality and reliability of our mamfacturing processes, simultaneously eliminating a significant proportion of our variable costs. In case you're unaware, filament winding is the process of winding resin-impregnated fibre on a mandrel surface in a precise geometric pattern. This is accomplished by rotating the mandrel while a delivery head, under computer control, precisely positions continuous strands of fibres on the mandrel surface. Compared to our existite, labour intensive, mamufacturing process this isvestment should provide us with significant advantages however, it does also significantly increases the company's operating leverage. Our target rate of return on equity has been 14% for many years. I realise that many rew employees feel that this target is too high but I feel we need to aim for the highest prof itability we can in order to keep our shareholders as happy as possible. The following table summarises composition Plastil financing Extracts from PlastiTubes' latest financial statements show the following: Balance Sheet of plastiTubes as at 31 September 2020 ($000) Current Assets 4,000 Current Liabilities 2,000 Non-Current Assets 47,000 Non-current Liabilities Preference Shares Ordinary Shares Retained Earnings Total L & OE 15,000 5,000 20,000 9.000 51,000 Total Assets 51,000 Bonds Preference Shares Ordinary Shares Amount (2000) 15,000 5,000 20,000 % of total 37.5% 12.5% 50.OX Rate of return 8.6% 12.05 14.05 From this data I have estimated Plastilubes' weighted average cost of capital as: WACC = (0.375 x 0.085) + (0.125 x 0.12) + (0.50 x 0.14) = 0.1168 or 12% Therefore the official hurdle rate for this and all future CAPEX decisions is 12%. If you have any further questions about these calculations, please direct those to our new project finance manager who has just graduated with a degree in finance and is more than qualified to explain things to you. As stated in Mr. Lazybov's memo from Part 1, Plastitubes is considering an investment in a new FRP Filament Winder that will improve the quality and reliability of its manufacturing processes, simultaneously eliminating a significant proportion of its variable costs. Filament winding is the process of winding resin-impregnated fibre on a mandrel surface in a precise geometric pattern. This is accomplished by rotating the mandrel while a delivery head, under computer control, precisely positions continuous strands of fibres on the mandrel surface. Compared to its existing, labour intensive, manufacturing process this investment significantly increases the company's operating leverage. The plant will cost $10 million plus a further $100,000 investment in inventory at the start of the project, and is expected to last for seven years before it needs replacing. The new plant is expected to generate an additional $6.8 million revenue in its first year and achieve a growth rate in revenues of 10% for the next two years, flattening out at 5% for the remainder of the plant's life. Variable costs are projected to be 45% of sales in the first year and will then grow at a constant rate of 4% thereafter (i.e. they are not 100% variable with respect to sales). Fixed costs (excluding depreciation) of $2.5 million are anticipated each year. The new plant would be depreciated on a straight line basis over the seven years to a residual value of $3 million. The company's production manager has asked your finance team to complete a financial analysis for the investment. He will make a recommendation to the board of directors based in part, on your financial analysis and report. a) Prepare a thorough analysis of the proposal on Excel. Print a copy of this analysis on a single A4 sheet and attach it to your assignment. (3 marks) b) From your analysis, recommend whether PlastiTubes should accept the proposed investment and explain why or why not. (1 marks) c) From your analysis, explain what might have happened if PlastiTubes had used Mr. Lazybox's. WACC (from Part 1) to evaluate this proposal. (1 marks) You have just received the following memo from the company's Chief Executive Officer George Lazyboy and have decided you need to prepare thoroughly for any questions that might arise from your colleagues. On first glance you are a little concerned with some of the calculations and feel you might have to talk briefly with Mr Lazyboy before the meeting as well. | (2 marks) After graduating with a B.Com (Finance) from the University of Auckland you have been employed by a company called PlastiTubes Ltd., as a project finance manager. PlastiTubes is based in Auckland's industrial area of Penrose and manufactures a variety of Fibre Reinforced Polymer (FRP) pipes and containers used for transporting and storing corrosive liquids. PlastiTubes supplies customers in New Zealand and Australasia who are mainly involved in the petrochemical and wastewater (sewage) treatment industries Their main product, FRP pipe, has an exceptional strength to weight ratio, and weight for weight is stronger than steel. The pipes also have good shock and impact resistance and excellent flow characteristics as a smooth glass-like interior finish reduces material build-up and improves fluid transmision transmission PlastiTubes is a medium sized company listed on the NZX and has 20 million shares on issue - the current share price is $2.40. In addition, PlastiTubes issued 5 million preference shares three years ago. These preference shares have a $1 face value and a fixed dividend of 12%p.a. The preference shares are currently trading at $1.50 each. The company's equity beta (B) is 1.20, the New Zealand market risk premium is estimated at 6.0% p.a., the yield on 10-year New Zealand government bonds is 2.50% p.a., and the company tax rate is 28%. The company's long-term debt consists entirely of 15,000 10-year bonds issued exactly five years ago (these are listed on NZDX). Each bond has a face value of $1,000 and an annual coupon rate of 8.5% (paid semi-annually). The bonds are currently trading at a yield to maturity of 5.23% p.a. Memo To: All Finance Staff From: George Lazybay - CEO Date: 29 Jamary 2021 Re: Capital Expenditure As you know, Plastilubes evaluates Capital Expenditure decisions using discounted cash- flows. The discount, or hurdle, rate is our company's weighted average cost of capital. This memo is to clarify our company's long-standite policy regarding hurdle rates for these investment decisions. Plastilules is considering an investment in a new FRP Filament Winder that will improve the quality and reliability of our mamfacturing processes, simultaneously eliminating a significant proportion of our variable costs. In case you're unaware, filament winding is the process of winding resin-impregnated fibre on a mandrel surface in a precise geometric pattern. This is accomplished by rotating the mandrel while a delivery head, under computer control, precisely positions continuous strands of fibres on the mandrel surface. Compared to our existite, labour intensive, mamufacturing process this isvestment should provide us with significant advantages however, it does also significantly increases the company's operating leverage. Our target rate of return on equity has been 14% for many years. I realise that many rew employees feel that this target is too high but I feel we need to aim for the highest prof itability we can in order to keep our shareholders as happy as possible. The following table summarises composition Plastil financing Extracts from PlastiTubes' latest financial statements show the following: Balance Sheet of plastiTubes as at 31 September 2020 ($000) Current Assets 4,000 Current Liabilities 2,000 Non-Current Assets 47,000 Non-current Liabilities Preference Shares Ordinary Shares Retained Earnings Total L & OE 15,000 5,000 20,000 9.000 51,000 Total Assets 51,000 Bonds Preference Shares Ordinary Shares Amount (2000) 15,000 5,000 20,000 % of total 37.5% 12.5% 50.OX Rate of return 8.6% 12.05 14.05 From this data I have estimated Plastilubes' weighted average cost of capital as: WACC = (0.375 x 0.085) + (0.125 x 0.12) + (0.50 x 0.14) = 0.1168 or 12% Therefore the official hurdle rate for this and all future CAPEX decisions is 12%. If you have any further questions about these calculations, please direct those to our new project finance manager who has just graduated with a degree in finance and is more than qualified to explain things to you. As stated in Mr. Lazybov's memo from Part 1, Plastitubes is considering an investment in a new FRP Filament Winder that will improve the quality and reliability of its manufacturing processes, simultaneously eliminating a significant proportion of its variable costs. Filament winding is the process of winding resin-impregnated fibre on a mandrel surface in a precise geometric pattern. This is accomplished by rotating the mandrel while a delivery head, under computer control, precisely positions continuous strands of fibres on the mandrel surface. Compared to its existing, labour intensive, manufacturing process this investment significantly increases the company's operating leverage. The plant will cost $10 million plus a further $100,000 investment in inventory at the start of the project, and is expected to last for seven years before it needs replacing. The new plant is expected to generate an additional $6.8 million revenue in its first year and achieve a growth rate in revenues of 10% for the next two years, flattening out at 5% for the remainder of the plant's life. Variable costs are projected to be 45% of sales in the first year and will then grow at a constant rate of 4% thereafter (i.e. they are not 100% variable with respect to sales). Fixed costs (excluding depreciation) of $2.5 million are anticipated each year. The new plant would be depreciated on a straight line basis over the seven years to a residual value of $3 million. The company's production manager has asked your finance team to complete a financial analysis for the investment. He will make a recommendation to the board of directors based in part, on your financial analysis and report. a) Prepare a thorough analysis of the proposal on Excel. Print a copy of this analysis on a single A4 sheet and attach it to your assignment. (3 marks) b) From your analysis, recommend whether PlastiTubes should accept the proposed investment and explain why or why not. (1 marks) c) From your analysis, explain what might have happened if PlastiTubes had used Mr. Lazybox's. WACC (from Part 1) to evaluate this proposal. (1 marks)