Role to play in the capital-budgeting process

Assignment Help Corporate Finance

Reference no: EM13214396

Capital Budgeting

You have just been appointed to the newly created position financial analyst position with the Australian company, Samphore Pty Ltd, which manufactures an innovative medical diagnostic test for breast cancer. Although the company has its operations in Australia, it was recently sold to a private equity company based in the United States whose shareholders are unable to utilise the value of the Australian Dividend franking credits. The new owners of Samphore Pty Ltd have just appointed a recently retired eminent pharmacological researcher to the head of the company. Yesterday, you received the following memo from this new CEO.

MEMO

To: Financial Analyst

From: CEO

Subject: New Product

The capital projects committee, which I chair, will be meeting soon to consider an investment to produce a new diagnostic test for prostate cancer that has recently been approved by the Australian health authorities. Although the regulatory approval to sell the test is five years, with an option to seek further approval after that time, the companies experience with other diagnostic tests is that it is likely to be superseded by a new test by the end of the initial five years. The following information has been provided by the accounting division with input from production and marketing.

Cost of new plant and equipment $7 900 000

Freight and installation costs $100 000

Estimated sales pattern

Year Number of units

1 70000

2 120000

3 140000

4 80000

5 60000

Sales price per unit $300/unit years 1 to 4; $260/unit in year 5

Cost of Sales $180 per unit

Annual fixed costs $200000

Depreciation prime-cost over 5 years with no salvage value

Working capital There will be an initial investment of $100 000 just to get the project underway. After that, extra investment will be necessary to bring the total of working capital up to 10% of the years estimated sales. This means that the total working capital will decrease from year 4. The final amount of working capital will be liquated at the end of year 5.

I am also told that the discount rate to evaluate this type of new product is 22% p.a. before tax which with the governments proposed reduction of the corporate tax rate to 28%, would be 15% p.a. after tax.

Prepare a report for me that addresses the following issues; Calculations are to be shown as part of your answer where required

1. I have read that accounting profits are not the appropriate measure of project benefits. Therefore, in which way should we measure the annual payoffs from this project?

2. Do Annual profits have any role to play in the capital-budgeting process?

3. How should we allow for depreciation in making this capital investment?

4. What is the significance of the Australian Tax system for our company when it makes capital-budgeting decisions?

5. What is the amount of the initial outlay?

6. What is the relevant amount of profits and cash flows returned by the projects each year?

7. What is the terminal cash flow for this project?

8. Show a cash-flow diagram that summarises the project outlay and future benefits

9. Compute the project's NPV and explain what it signifies?

10. Compute the projects IRR and explain what it signifies?

11. Should we invest in the project? Why or why not?

Questions to be completed

Complete all parts of the Case Study in chapter.

Assume that if taxation is relevant to this question, any taxes due are payable in the same year as net earnings are made.

Relevant word limit guidelines and mark allocations are as follows:

Part 1: no more than 100 words for this part of the question - 4 marks

Part 2: no more than 75 words for this part of the question - 3 marks

Part 3: no more than 100 words for this part of the question - 3 marks

Note: This part of the question is asking for a brief explanation of the relevance, if any, of depreciation to the capital budgeting process, including how any calculations (where required) would be undertaken given the relevant information provided in the question.

Part 4: no more than 75 words for this part of the question - 3 marks

Part 5: 2 marks

Part 6: 8 marks

Part 7: 3 marks

Part 8: 3 marks

Part 9: no more than 50 words for this part of the question - 3 marks

Note: For this part of the question do not discuss a final accept / reject decision as this is requested in Part 11 of this question. Instead, relate the project's NPV to the information provided in the question.

Part 10: no more than 50 words for this part of the question - 2 marks

Note: For this part of the question do not discuss a final accept / reject decision as this is requested in Part 11 of this question. Instead, relate the project's IRR to the information provided in the question.

Part 11: no more than 25 words for this part of the question - 2 marks

Note: For this part of the question your response should be based on the answers prepared for Parts 9 and 10 of this question.

Reference no: EM13214396

Questions Cloud

Explain solution of a weak base nh4oh : What ions and/or molecules are present in relatively large proportions in a solution of a weak base NH4OH (aq)?

What level of tax would achieve optimal level of pollution : Suppose that the marginal damages to society from air pollution are MD=e-25, where e is the level of air pollution. Suppose also that the marginal cost of reducing the air pollution on the part of firms is MC=200-2e.

Calculate the pay-back period for each project : Calculate the NPV for each project using each scenario's NPV rate and calculate the pay-back period for each project

Explain what is the mass of the sphere if lead has density : A spherical ball of lead has a diameter of 6.5 cm. What is the mass of the sphere if lead has a density

Role to play in the capital-budgeting process : Do Annual profits have any role to play in the capital-budgeting process and how should we allow for depreciation in making this capital investment and what is the significance of the Australian Tax system for our company when it makes capital-budget..

Would a regulation increases marginal cost of fishing effort : When trying to reduce the degree of inefficiency from an open-access fishery, would a regulation that increases the marginal cost of fishing effort by banning certain types of gear or a tax on effort be equally efficient.

Determine the fishery is private property : In the economic model of the fishery developed in this chapter, compare the effect on fishing effort of an increase in cost of a fishing license with an increase in a per-unit tax on fishing effort that raises the same amount of revenue. Assume th..

What would be impact a tax rate of 40 percent : You are required to suggest the firm on the investment proposal. What would be impact if a tax rate of 40% is considered for the project?

Discuss the impact on profitability in both situations : An accident has occurred in which chemicals leaked into the ground water nearby, the community is unaware. Assess the costs involved in cleaning up the water immediately (confessing) versus hiding the fact.

User Account

All Pages