Reference no: EM133115303
Andrew plc is a medium sized conglomerate financed by a combination of debt and equity. Following the board of directors' decision to expand its activities to benefit from the current economic climate, four potential projects have been identified. Their cash flow details follow.
|
Year
|
Retail
|
Finance I
|
Finance II
|
Tobacco
|
|
0
|
(2,000,000)
|
(2,500,000)
|
(3,000,000)
|
(1,000,000)
|
|
1
|
1,000,000
|
|
1,200,000
|
920,000
|
|
2
|
1,000,000
|
|
1,200,000
|
920,000
|
|
3
|
1,000,000
|
|
1,200,000
|
|
|
4
|
|
2,500,000
|
1,200,000
|
|
|
5
|
|
2,500,000
|
1,200,000
|
|
Andrew plc does not have any internal funds with which to undertake the projects and will have to rely on the external markets. As a result of the credit crunch, however, the finance director has negotiated only one agreement successfully: SOB plc has offered the company a £6,000,000 irredeemable loan, the cost of which has been estimated at 8%.
REQUIRED:
(a) For the benefit of the board of directors at Andrew plc, determine the optimal investment strategy.
(b) A new finance opportunity has arisen: a senior manager at SOB plc has offered Andrew plc the full amount required to pursue all the above projects, in twelve months time (with nothing now) at the same terms and conditions as the original agreement. Determine whether it is worth the company's while postponing its investment plan; support your decision with appropriate calculations. You may assume that the company's investment plans can be postponed by twelve months.
(c) Explain the effect of each of the following on your strategy in (a) above (you are not expected to undertake any further computations).
i. the two finance projects are mutually exclusive;
ii. the retail project is dependent on the finance I project; and
iii. the tobacco project is dependent on the retail project.
(d) Discuss three drawbacks of your propositions in (a). and (b). above for Andrew plc.
Notes:
i. All cash flows arise at the end of the period unless otherwise suggested.
ii. Assume for parts (a) - (c) only that projects may be scaled down, although none of them can be undertaken on a scale greater than that stated above.