Business finance

| July 25, 2016

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Assessment Task 3: Business Finance

Word Length: 2,000 words plus calculations

Value: 30% of overall grade

Format: Written report

 

Task description

Assume you are a manager in the Whizz Bang Corporation Ltd (WBC), a large organisation

whose business is to manufacture and wholesale spare parts for heavy transport motor

vehicles. You are presented with three scenarios that you are required to address and

respond to. You must address all three scenarios and incorporate your answers into a

single cohesive report that is addressed to senior management.

 

Scenario 1: Capital Acquisitions

One of your team members provides you with a request seeking your approval to replace

an expensive worn-out piece of equipment. As it is a replacement, very few details are

provided and it is evident that the staff member automatically presumes your approval. In

the past, your predecessor had approved all such requests.

Required

Discuss this scenario, in particular describing what information you should demand to know

before you approve the release of capital funds for such a request, and why you would

require that information.

Weighting: 25 marks of the total 100.

 

Scenario 2: Project Proposal

You have identified a potential opportunity for WBC, which involves undertaking a project

that will have a ten-year life. The project requires an initial purchase of equipment and

furniture totalling $4,500,000, plus ancillary programming capability and machinery

costing $1,500,000. The equipment and furniture will depreciate and have a salvage value

of $500,000 at the end of the project’s life, and the programing machinery will have nil

salvage value at the end of the project’s life. Depreciation is calculated on a straight-line

basis over five years.

The operating results for the project are estimated as follows:

Sales will be $3,050,000, $4,000,000 and $5,000,000 respectively in each of the first

three years of operation, expected to grow at 10 per cent per annum for a further four

years thereafter, and then settle to a growth of 5 per cent per annum indefinitely

thereafter. In the event of not undertaking this project, all of this income would be lost.

Variable costs associated with the project will be 65 per cent of sales.

Fixed costs associated with the project will be $400,000 in the first year and expected to

grow at 5 per cent per annum thereafter.

Even though this project will not add any additional cash flows expenses to head office,

WBC has a policy of allocating a charge of $200,000 a year for head office and

administration costs for each substantial project.

Research about the best technology for this project and its capability was conducted

during the previous year at a cost of $300,000. It yielded valuable information.

The following information is also provided:

The corporate tax rate is 30 per cent.

Financiers of this type and risk in this industry are presently requiring a rate of 12 per cent

after corporate tax.

In order to undertake this project, WBC is considering various financing options. One

option is to borrowing $5,000,000 at 7 per cent per annum. This loan will be paid off in 10

equal annual instalments.

Required

Evaluate this project, and provide a report to WBC management discussing whether or

not you recommend it should undertake the project, providing a full explanation of your

recommendation.

As support for your recommendation ensure your answer includes the following:

Calculations of the NPV, IRR, and the payback for the project and an analysis of the results.

Justify the correct discount rate to be used in evaluating the project.

Your assessment of the advantages and disadvantages of each methodology (NPV, IRR

and payback), and which you therefore recommend is applied to evaluate this project.

Details of any other (financial and non-financial) matters you would consider before

making a recommendation in respect of this project.

Weighting: 40 marks of the total 100.

 

Scenario 3: Project Financing

WBC is currently financed using debt and equity with a targeted debt to equity ratio of one

(D/E = 1). Its debt financing is from three sources, overdraft, bank bills and debentures, with

the ratio of overdraft to bank bills to debentures of 1:2:3. Its equity is ordinary shares. These

ratios represent the long-term capital structure target for WBC.

The debenture pays an annual coupon of 12 per cent per annum on its $1,000 face value.

The remaining term of the debenture is six years. The debenture is currently priced

$922.23.

The bank bills issued by WBC are ninety-day bills, with a face value of $100,000 and are

currently priced at $97,593.58.

The bank overdraft rate is 1 per cent per annum above the bank bill rate.

The ordinary shares sell for $8.00. The projected dividend for year one is $1.10. Dividends

are expected to grow at 6 per cent per annum indefinitely.

Required

Calculate the Weighted Average Cost of Capital (WACC) for WBC, assuming a tax rate of

30 per cent.

Hint: this requires a calculation of the effective annual cost for each source of finance.

Discuss whether the WACC could be used in the above project evaluation, and if so how.

Include a discussion of any restrictions that apply to the use of WACC?

Weighting: 35 marks of the total 100.

 

Evidence of Reading and Research

You need to provide evidence of researching additional relevant peer reviewed

academic articles. These articles are in addition to those provided in the Managing

Finance readings.

Assessment Format:

Report format including:

 

Report format including:

  1. Assessment Cover Sheet
  2. Title Page
  3. Executive Summary
  4. Table of Contents
  5. Introduction
  6. The Body
  7. Conclusions
  8. Recommendations
  9. List of References
  10. Appendices

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