Reference no: EM133068010

ACCT6004 Finance - Southern Cross University

Assessment: Business Case

Case information

The assignment is based on the case information below. While the company Lego, does exist, the financial data as well as the scenario in this case study are fictitious1, however the context is not. Many businesses and government departments face similar investment decisions in order to remain competitive as well as being more environmentally and socially responsible.

The Lego Group is a privately owned company based in Denmark and produces toys for both children and adults that are based on building structures from interlocking plastic bricks.

The company is in the process of becoming more environmentally conscious and moving away from the issue of traditional style plastic bricks that take many years to breakdown and using plant based materials from sustainable sources to manufacture their toys. This strategy aligns with their goal of tackling climate change issues.

This product (BIOLego) is totally new to the market and no other competitor has yet to initiate a ‘lego' style product like it. The benefits of this product are that they are made from sustainable plant products and recycled plastics that are protecting the soils, waterways and oceans. For this reason, The Lego Group believes that this product will cost more to produce and install than its existing manufacturing capability and has more risk involved with its rollout into the current market than that of its existing products.

This new product will require an upfront expenditure on a new piece of machinery to manufacture the product. There is currently not one in the marketplace and will need to be custom built. The company has received quotes from certain manufacturers of machines to build this machinery and is satisfied that these quotes are realistic in terms of cost. The estimated cost of the new machinery totals $450 million. The company plans on financing this amount from their bank at quoted interest rate of 2.57% per annum.

The engineers of the company believe that this machine has a useful life of 6 years before needing to be updated with new technology as it comes available in future years. The machine will be depreciated using the prime cost method to zero over the life of the asset. At the end of the project, some of the machine can be sold off in parts for scrap at a total of $10 million. The machine will need to be dismantled and removed and at a cost of $3 million.

The company has spent several years researching and developing this product at a combined cost of
$4 million. The CEO of The Lego Group has asked you to prepare a financial analysis of this initiative. They have asked you to provide a summary of your analysis, as well as providing your recommendations in the form of a short memo.

The sales and marketing department have conducted several focus groups with customers and are satisfied that BIOLego will be successful. It is estimated that revenues in the first year of the product's introduction will total $170 million, however this is not certain. These sales are forecasted to increase by 30% each year in years 2, 3, 4 and 5 as an increase in awareness of the product becomes evident. By year 6, it is expected that sales will increase by 70% as this product now takes over from their existing plastic-based products. However, due to the focus groups only targeting a small group of customers, the team are concerned that this product may not be as successful as forecasted so in their recommendations they have estimated a 30% standard deviation in the estimated revenues.

The sales and marketing team have also highlighted that the existing products sold by the company (based on plastic products) is likely to see a fall in sales due to the introduction of the new product. The product currently generates $120 million profit before tax for the company each year and it is estimated that this will fall by 50% with the introduction of BIOLego.

The production department have estimated that production costs will be equal to 45% of the forecasted revenues each year. There will also be a requirement for the company to have additional working capital on hand for this project equal to 15% of each upcoming year's sales forecast. This working capital forecast is relatively certain and based on previous production requirements of the company. The investment in this additional working capital will be made at the beginning of the project and will be fully recovered at the end of year 6, the last year of the project.

Other additional costs related to the project are as follows, (1) marketing costs $7 million (this is a best guess forecast) in the first year only; (2) maintenance costs of $4 million per year (certain forecast) and administration costs of $3 million per year increased by 2% each year after year 1 (certain forecast). The Lego Group have spent $1.5 million on feasibility studies for the project.

The Lego Groups financiers have advised them that the company's weighted average cost of capital is 8% and is subject to a 30% income tax rate. It is assumed that all taxes are paid in the year of income to which they relate.

Required:

Prepare a spreadsheet financial analysis of the proposed project and (2) a memo to the CEO of The Lego Group that summarises your key results and provides recommendations on the project. Note carefully the following points:

• Analyse base case (expected) cash flows and potential uncertainty.
• For your base case analysis, calculate the five investment decision criteria listed in the relevant
topic's Overview document.
• If you make any assumptions beyond those given in the case information, explain them.
• Recommendations should address the decision suggested by the base case, along with further follow up or other matters the company should consider prior to making a final decision.

• Include an appendix to the memo that provides a readable screenshot(s) of your base case cash flows, the purpose of which is to allow the CEO to see line item detail without needing to spend time going to the spreadsheet itself.
• Within the memo body, you are advised to use tables and/or figures to assist decision makers quickly see main points and to visualise your analysis results but ensure the tables and figures are discussed or explained.

Attachment:- Business Case - Case study.rar