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This assignment has a 25% weighting in your overall mark for this unit and focuses on content from Weeks 6, 7 and 8. The assignment will be marked out of 25 and marks will be allocated as indicated in the rubric below. Your total assignment submission will consist of a word document that should not exceed 1,000 words (excluding reference list), plus a spreadsheet submission.
The assignment is based on the hypothetical case information below.
Pinto Limited has recently been subject to significant competition from overseas manufacturers with much lower costs. To combat this, Pinto is considering a project that will see it move into a new product market considered riskier than its current operations. The CEO has asked you to undertake a financial analysis of the proposed project and present your recommendations in a short memo. As part of your financial analysis you will calculate NPV, IRR, payback period, discounted payback period and profitability index.
The project requires an upfront investment in plant and equipment of $15 million, which will be depreciated on a straight-line basis over the five-year life of the project. The equipment is not expected to have any significant salvage value at the end of its depreciable life.
Pinto paid $25,000 in fees to consultants for a market analysis related to the project. This analysis predicted sales volume of 200,000 units in the first year, which would grow by 50% per year in years two and three, and fall by 50% in each remaining year as demand wanes. Selling price in the first year is expected to be $75 and grow by 3% each year after that.
Pinto's operations manager has estimated cost of goods sold for the project will equal 60% of sales revenues and selling, general and administrative expenses directly related to the project (excluding depreciation) will be $1 million in the first year and increase by 5% per year thereafter. The operations manager has not included in his estimates any cost for a project operations base because the plan is to use a building the company already owns. Currently Pinto rents this building to another company for $250,000 per year.
The project will require an upfront investment in net working capital equal to 20% of the year 1 sales revenue forecast. This investment in working capital will be fully recovered at the end year.
The company has a 10% weighted average cost of capital and is subject to a 30% tax rate.
Required: Prepare (1) a spreadsheet financial analysis of the proposed project and (2) a memo to Pinto's CEO that briefly explains and justifies your chosen methods and any assumptions made, summarises your findings, and presents your recommendations on the proposed project.
IN RESPONSE TO:
Pinto Ltd has been presented with a capital budgeting decision. This decision is important considering the current market conditions and for the company to fight the competition. In order to make a decision, various financial measures such as NPV, IRR, Payback period and Profitability index have been used.
The cash flows have been calculated for a period of 5 years and the financial computation is for a weighted average cost of capital of 10%.
A tax rate of 30% has been specified. The net profit after tax has been calculated based on this tax rate.
Other qualitative factors relevant to production have been considered conducive.
- To analyse the market and look for profitable options, Pinto Ltd has so far spent $ 25,000 for consultant fees.
- The investment on equipment/machinery would cost $15 million.
- According to the case, Pinto Ltd. has to pay taxes at a rate of 30%.
- Depreciation is done on the basis of straight line spread over a service life of 5 years.
These facts are key for making the capital budgeting decision. Based on the calculations, it is clear that other than the initial outflow of cash for an investment of $ 1,650,000, the project has regular cash inflows that can help to retrieve the initial investment. This is in spite of the current market conditions, and if the market performs better than the forecast, the company would be able to perform better than most of its competitors.