Reference no: EM133120012

1. Wellfully Limited (hereafter known as "Wellfully") ordinary shares are listed on the Australian Securities Exchange (ASX). Wellfully's 2021 Annual General Meeting ("AGM") revealed plans to construct a new manufacturing facility in Dongguan, China to produce its own cosmetic brand. Wellfully has already performed a substantial amount of data analysis related to the new facility that has cost $31,000 to date. The capital expenditure of $785,000 associated with the construction of the new facility and the annual operating expenses are substantial. Therefore, before Wellfully commits to building the new facility a financial analysis is needed to determine if it will contribute to the goal of creating wealth for its shareholders. You have already converted all amounts into Australian dollars.

2. The capital cost of the building is expected to be $785,000. Wellfully must also purchase $220,000 of plant and equipment ("P&E"). Wellfully has $3.2 million cash and it plans to use $300,000 of this amount to pay for the building which will reduce the capital cost to just $485,000. If the new facility is built, a piece of idle equipment must be sold. The equipment had a total capital cost in 2006 of $220,000 and has an annual depreciation expense of $11,000 for the years 2007 to 2026 inclusive. The equipment can be sold today for $130,000 and Wellfully will use the entire sale proceeds to distribute a $130,000 dividend to its shareholders today.

3. According to the AGM (see Slide 7 of ASX announcement on 1/12/2021) Wellfully recently completed a comprehensive brand review to respond to a changing consumer landscape by engaging with several high-profile social influencers. While the influencers have already been paid, there is debate among management about whether the $60,000 tax-deductible amount that was paid to the influencers should be included as a cash outflow in the year 2022.

4. Wellfully plans to construct the new facility in the year 2022 and for capital budgeting purposes the first year of cash flow will be in 2023. Cash sales in 2023 are anticipated to be $460,000 and you forecast that with ongoing endorsement from prominent influencers that a sales growth rate of 4% p.a. for each of the next ten years is achievable.

5. At the 2021 AGM, Wellfully stated that it is budgeting to achieve a net profit for 2022 of $1.22 million and increasing it by $150,000 for 2023.

6. Starting in 2023, employees at the Dongguan facility will receive annual training. Wellfully performs all training in-house using a dedicated facility that was established in 2019. The facility has an annual budget of $270,000 and inducts new employees in all aspects  of the cosmetics manufacturing. Ordinarily, Wellfully would issue an intercompany transfer of $75,000 per annum for staff training. However, the training division has sufficient spare capacity to train the new facility's staff without the facility incurring any additional costs. The accounts department recommends the $75,000 annual training expense be treated as an intercompany transaction between entities within the new products division.Annual variable cash costs at the new facility are expected to be 53% of each year's cash sales. Annual fixed operating costs are forecast to be $37,000. Wellfully's depreciation expense for 2021 was $85,562 (Source: 2021 Annual Report, Page 35).

8. Wellfully will perform the financial analysis of the Dongguan facility over a ten-year period. The Australian Taxation Office (ATO) confirms that for tax purposes the Dongguan building has a twenty-five-year life and the new P&E have an eight-year tax life. In Wellfully's experience, P&E can be operated effectively for a full ten years before they need replacing. Wellfully's management accountants depreciate all assets over an operational six-year life.

9. Wellfully will borrow $200,000 today to partly finance the new facility. The ten-year interest-only loan has annual interest repayments of $8,000 (assuming a 4% p.a. rate). Wellfully's accountant confirms that interest payments are classified as a business expense and are therefore tax deductible.

10. Wellfully's total advertising expense for 2023 is already budgeted at $125,000. To promote the new products, Wellfully will approve a further $30,000 of advertising in 2023 only. Because this increased marketing expense will reduce Wellfully's profits in 2023, managers have suggested that the company's entire $155,000 advertising expense for 2023 be depreciated over the new facility's ten-year useful life. The ATO states that advertising expenses associated with the new facility can be claimed as a business expense in the year incurred.

11. For cost accounting purposes Wellfully must allocate overheads across each business unit. Therefore, it is proposed that the Dongguan facility be charged $25,000 of the Perth head office costs of $118,000 p.a.

12. The Dongguan facility will be located close to major transportation hubs allowing substantial efficiency benefits in transportation costs and a "faster time-to-market" (Source: 2021 Annual Report, Page 4) through the use of "specialist logistics and supply-chain management". Wellfully expects these benefits will translate into a reduction in freight costs across the entire organisation by $73,000 each year.

13. Wellfully assumes that the Dongguan building can be sold for $320,000 in the year 2032. At any point in time the resale value of the P&E is just $26,000. Wellfully assumes that it will have cash holdings of $4.4 million ten years from today. You note the ATO regulation 
that all non-current assets be depreciated to zero.

14. If the new facility proceeds, then Wellfully will implement a private placement to raise $200,000. The CEO's annual salary in 2022 is $473,000 and is not expected to change whether the Dongguan manufacturing facility is approved by the Board of Directors or not.

15. If the Board approve the new facility Wellfully anticipates that it will require an additional $86,000 of inventory today on top of the existing level of $115,000. Accounts payable is expected to remain at $170,000. The accounts receivable balance will increase from the current level of $215,000 to $260,000 if the Dongguan facility proceeds.

16. Wellfully has a required rate of return of 11%. Assume the company tax rate will remain at 30%. "Assets and liabilities are presented in the statement of financial position based on current and non-current classification." (Source: 2021 Annual Report, Page 41).

REQUIREMENTS

All answers must be entered into the preformatted EXCEL spreadsheet available on Canvas. Questions 1 to 4 require information relating to the capital budgeting decision of the proposed Dongguan facility. Questions 5, 6 and 7 require you to supply additional information regarding Wellfully's performance and share valuation.

Capital Budgeting Information

Present an itemised breakdown (and the total) for each of the following:

1. The cash flows at the start.

2. The cash flows over the life.

3. The cash flows at the end.

4. What is the NPV of the proposed Dongguan facility, and your recommendation?

Additional Information

5. What is the percentage return on Wellfully shares for the year 2021? You will need to perform some research and obtain the share price on 04/01/2021 and 31/12/2021. You also must include any dividends paid in 2021 i your calculation.

6. Wellfully has announced substantial losses in the last two financial years. According to the AGM presentation, why do Wellfully believe they have the ability to continue as a going concern?

7. Analysts forecast that Wellfully will pay its first dividend of two cents per share in the year 2025. This dividend is then predicted to increase at a constant rate of 2% p.a. What is a fair price for a Wellfully share in 2022?