Business Finance 2 – Assignment - 2010 (Semester 2)
This assignment is intended to be done in a group up to 3 people. Those who chose to do it individually must do
留學(xué)生dissertation網(wǎng)case 1 and 3 only. Groups of 2 must do all 3 cases. No groups in excess of 3 are permitted. The word limit is 1500
to 2000 words in total - appendices (including, for example calculations) can be attached and will not be counted
in the word limit. Penalties may apply for assignments that are substantially over the word limit. Due date is
Thursday 7th October, 4 pm and assignments are to be submitted into the assignment box in the UoA
Undergraduate Student Hub on ground floor 10 Pulteney Street. Penalties of 5 % will apply for every day late.
If you are uncertain about the information provided you are required to make a “reasonable” assumption.
Case 1
Cox Container Corporation (CCC) started in Adelaide in 1950, providing plastic injection moulded products
to a wide variety of customers. The most popular product, by far, was plastic containers for food or label
packaging and industrial uses. Virtually any size, colour and translucency could be delivered by CCC. The
company was not competitive with firms producing wide variety shapes for plastic products. Within their
niche (round containers) however, CCC could be considered the leading manufacturer, with three other
firms running close behind. CCC experienced some reduction in the revenues due to the recent economic
crisis, though the sales growth has never become negative at any point since its foundation. The main key to
success in the industry, it seemed, was to hold the leading competitive position. Shan Li, a recent graduate
being employed as an analyst in the headquarter of CCC, has been asked to evaluate whether the company
requires a great deal of new investments to remain competitive, with inference specifically to three different
proposals of strategic development proposed to the Board early this year.
The first proposal involves the construction of a new plant offshore to expand its customer base. The
Philippines seems to be the best venue for having a secured legal arrangement and lower labour cost. In
particular, Ivan Chemicals (IC), one of CCC’s best customers which operates several manufacturing lines in
the Philippines (in an effort to streamline IC’s inventory management) once suggested that CCC should
http://www.ttc-switch.com/thesis_sample/Canada_Thesis_Sample/build a new plant adjacent to one of IC’s facilities, in which case it promised to switch from his local
suppliers to CCC for all of his packaging needs given the same price tag. IC currently orders only 10% of
its purchases of its production requirement in the Philippines from CCC. IC had spent $2.5 million on#p#分頁標(biāo)題#e#
packaging materials last year, and this demand is expected to remain relatively stable over the next 10 years
to come. Of course, CCC estimates that the new plan should have a large enough capacity to allow CCC to
not only meet IC’s current and future needs but also to allow the company to expand its customer base in the
region. Essentially, it is most likely that a rapid sales growth of 25% pa in the first 5 years will be
attributable to the latter. This will be followed by a stable growth of 7% pa afterwards. According to the
engineer’s report sent in recently, the cost of establishing the manufacturing facility in Philippines would be
around $5 million at the prevailing exchange rate. It also requires an additional working-capital outlay of
approximately $120,000 once the new operation commences early next year. Extra investment may be
necessary afterwards as the company’s current operating policy requires that the total working capital is
always kept at 10% of estimated sales. The new plant will be erected on a site currently being leased at
$250,000 per year. Thereafter, the lease is expected to grow in line with the local inflation rate at 7% pa.
The current market price of the site is estimated to be around $20 million though the owner has no intention
to sell it. While the scrap value of the new plant is estimated to be approximately $1 million after a 10-year
economic life, it will be fully written off for the tax purpose. The reduced labour cost is expected to provide
some production savings, estimated to be 10% of the current price tag. CCC will incur, however, an upfront
cost of labour training and personnel services for local workers who will be hired to operate machines at the
new plant, expected to be around $100,000, not to mention that it had cost the company roughly $100,000 in
the prior quarter to produce the engineer’s report and site survey.
The second proposal favours overhauling current equipment with the new moulding machinery system as it
is recognised that the inefficiency of existing machines has contributed to backlogs in the past. The new
system is fully integrated with the advantage of automation in some parts of the production process which
will help to cut labour costs attributable to a savings worth around 3% of the current price tag. In addition,
some of the costs of poor quality can be reduced, which itself will lead to an increase of 2% in the profit
margin which is currently affixed at 20% of the sale price. By providing better quality products and
avoiding late deliveries, the Board is convinced that it would gives the company a competitive edge and
induces an immediate sales improvement of 3%. This advanced technology can be purchased at $5 million
and entails a set-up cost of $1 million. While CCC is allowed to depreciate it to zero value, a salvage value
of $400,000 is believed to be realised at the end of its useful life of 10 years. The Board is excited to find#p#分頁標(biāo)題#e#
out that the new machinery will not only improve productivity but also eliminate the production of toxic
solid residue and help to save at least $100,000 per year on environmental costs by eliminating fines and
clean-up costs. The replaced machinery was purchased 5 years ago at a cost of $3 million and a depreciable
life of 15 years, also fully written off for the tax purpose. Its current market value is $1.5 million while the
company estimates it will remain capable of full scale production for another 10 years and get a salvage
value of $200,000 in 10 years time.
The third proposal targets at a new product design recently developed by CCC’s research team, the so-called
scoll container. It has double walled cap allowing the label (or extra promotional information about the
product) being placed within which can be released and retracted easily by twisting the package. The
prototype has been evaluated and approved by several brand owners, with some having particular
excitement over this innovative design. Upon Shan’s request, the head of the design group also provided
some details of the relevant costs and other issues entailing from a full-scale production process. It is
envisaged that it will replace the current production line of plastic takeaway containers, which proven to be
unprofitable (just break-even) over the last couple of years. While most equipment can be redeployed, some
additional machinery will be needed, costing around $4.7 million in total. The entire production facility is
expected to have a useful life of 5 years and a zero salvage value. While the total cost [including fixed and
variable costs such as material, labour, administrative costs] is to remain the same at $1 per unit, the new
product will be sold at $1.20 each. The initial marketing survey results indicated that the company would be
able to sell $5 million units in the first year with sales growing at a rigid 20% each year over the first 3 years
and thereafter 5% per year. The new production would entail an immediate increase in working capital of
the $500,000 and increase with in line with sales thereafter.
In an independent market report produced early this year, it is forecasted that the demand for company
products will continue to grow at 6% each year. Its sales figure was $10 million last year when the current
production capacity was reached. The company used to use a weighted average cost of capital when
evaluating the capital budgeting process, so it felt the current rate of 10% would be an appropriate discount
rate in this instance. The company tax rate is 35%. Inflation is currently 5% and expected to remain at this
level for the next 20 years.
You are required to carry out a detailed analysis of the proposals and advise the company which of these
proposals they should adopt. In your report you should provide justification for the your team’s#p#分頁標(biāo)題#e#
recommendations, including consideration of other intangible factors that you feel are relevant.
Case 2
Yessy, the product development manager for the Lumiere Pharmaceuticals (LP) has joined the firm about 7
years ago. With a bachelors degree in Chemistry and an Master in Applied Finance from the University of
Adelaide, Yessy has been fairly successful in his professional career. Prior to working at LP, Yessy had
been responsible for the launching of three highly successful drugs at another mid-sized pharmaceutical
company. It didn’t take long for the head-hunters to find him and shortly thereafter LP made him an offer
that was too good to refuse. LP is a fairly large pharmaceutical company that has a number of patented
drugs under its belt. With a number of the firm’s patents expiring in the next three years, there has been
some pressure to expand its production lines. Yessy has been asked to make recommendations of new
investment to the Board, specifically with inference to two new drugs recently developed within LP’s
Research Department.
The Vision Research division recently invented a new drug, nicknamed ClearView, for the cure of myopia,
which has shown tremendous promise in the preliminary tests. The project leader, Andrew, is very
confident that this new drug would revolutionise the world of ophthalmology. Upon Yessy’s request, he
also provides some standard cost estimates if the product is approved and launched in early this year.
Development costs 20 million
Testing costs: 10 million
留學(xué)生dissertation網(wǎng)Initial Marketing costs: 12 million
Initial outlay 42 million
The new drug is expected to be block-buster which will help to increase the company’s market share from
25% to 35% in the first year. The sales revenue generated from this product alone is expected to grow at a
solid rate of 10% pa in the first three years and stay in line with inflation thereafter until its patent expires in
10 years.
The second recommendation is to introduce SerexX, a fully-developed antibiotic product, to the company’s
portfolio. This product has passed the testing phase and can also be launched right early this year. The
initial marketing cost is around $10 million. Its sales revenue is expected to start off from $3.2 million in
the first year and continue to grow in line with the inflation over the next 10 years.
The manufacturing of either product would be done in an unused plant of the firm which would otherwise be
leased out for $100,000 per year. Required equipments costing $5 million are expected to have a salvage
value of $300,000 after 10 years though they will be fully written off for the tax purpose. Fixed costs were
estimated to be $1.5 million per year while variable production costs are expected to be attributable to 25%#p#分頁標(biāo)題#e#
of sales revenues in each case. To get the project underway, additional inventory of $500,000 would be
required. The company would also need to increase its account payable by $100,000 and its account
receivable by $200,000. Yessy estimates that the net working capital committed to each production line
would be maintained at 20% of its sales each year thereafter.
The company’s last year sales revenues were reported as $90 million. The weighted average cost of capital
was calculated to be 14%. The current inflation of 5% pa is expected to remain over the next 20 years, so
does the company’s tax rate of 34%. You have been asked to advise the manager which one of these
proposals should be adopted using NPV analysis. In addition you need to provide some sensitivity analysis
using the numbers that could be questioned by the committee. This time, the main concern is that the
expectation of the sale growth in the first recommendation would turns out to be optimistic. You believe
there would be a 20% chance that sales growth of Clearview in the first three years will be 25% higher and a
40% chance of being 25% lower. The initial marketing cost for both products may also be 25% lower (10%
chance) or 25% higher (40% chance). Another factor of uncertainty stems from the requirement of
obtaining approval from the Food and Drug Administration (FDA) prior to marketing the drug. How would
the number turn out after taking into account consideration the contingency of a 1- or 2- year delay in
getting FDA’s approval for both drugs?
Case 3
In September 2010, Inez Marcus, the chief financial officer for Sugar-ez Manufacturing, was given the task
of assessing the impact of a proposed risky investment on the firm's bond and stock values. The project is a
significant investment for the firm, of $16 million and involves manufacturing a household size catalytic
converter for households to run a small ultra quiet generator fuelled by household waste with sugar content
to provide electricity supplies. However market testing says that while the generator might take the market
by storm, equally with the research into alternative energies now in train, a superior product may develop
quickly. The investment will be funded using a 1 for 3 rights issue.
To perform the necessary analysis, Inez gathered the following relevant data on the firm's bonds and shares.
? Bonds: The firm has one bond issue of 10,000 bonds currently outstanding. It has a $1,000 par
value, a 9 percent coupon interest rate, and 12 years remaining to maturity. Interest on the bond is
paid semi-annually, and the bond's required current market price is $1,085. After a great deal of
research and consultation, Inez concluded that the proposed investment would not violate any of the
bond's numerous provisions. Because the proposed investment is so large, undertaking it will#p#分頁標(biāo)題#e#
increase the overall risk of the firm, including bankruptcy risk and she expects that if it is
undertaken, the required return on these bonds will increase by between 1 and 2 percent.
? Shares: During the immediate past five years the annual dividends paid on the firm's ordinary shares
(1.2 million on issue) were as follows:
Year end June Dividend per share
2010 1.90
2009 1.70
2008 1.55
2007 1.40
2006 1.30
The firm expects that without the proposed investment the dividend in 2010/11 will be $2.09 per
share and the annual rate of growth (rounded to the nearest whole percent) will continue in the
future. However there is also a small chance (say 10% probability that historic growth will slow to
about ½ the historic rate). Currently, the required return on the common stock is estimated at 14
percent. Inez's research indicates that if the proposed investment is undertaken, the 2011 dividend
across both the existing share base, and the new shares issued under the right’s issue will rise to
$2.15 per share and the annual rate of dividend growth will increase to 13 percent. She feels that in
the best case (based on the expectation of NPV of the project) the dividend would continue to grow
at this rate each year into the future, and in the worst case the 13 percent annual rate of growth in
dividends would continue only through to 2012/2013, and then at the beginning of 2013/14 the rate
of growth would return half the rate that was experienced over the last 5 years. However as a result
of the increased risk associated with the proposed risky investment, the required return on the
ordinary shares is expected to increase by 2 percent to an annual rate of 16 percent, regardless of
which dividend-growth outcome occurs.
Armed with the above data, Inez must now assess the impact of the proposed risky investment on the market
http://www.ttc-switch.com/thesis_sample/Canada_Thesis_Sample/value of Suarez's bonds and stock. To simplify her calculations, she plans to round the historic growth rate
in common-stock dividends to the nearest whole percent.
Assist Inez by providing a quantitative valuation of the firms bonds and shares in a base case where the
investment is not undertaken, versus an alternative case where it is undertaken. Consider the implications of
the best case and worse case in dividend growth, the implications with respect to project NPV, and the
alternative views on impact on required return on bonds, and the implication for the valuation. What should
Inez recommend with respect to whether the company should proceed with the investment, including
commenting on the probability of best versus worse case outcomes for the project and its implications for
the recommendations?