EFN406: MANAGERIAL FINANCE Assignment: Part B, Capital Budgeting | Complete Solution

General Information

1. Marks: 10 - You must have the correct answer and a correct explanation to gain the full marks allocated to each part. Part marks will be allocated but you should not expect to get more than half marks if your answer is incorrect. Evaluate two projects 5 marks for each. Be sure to show full explanations. Ambiguous answers and contradictory statements will be penalised. Project 2 must be done in excel.
2. Weight: 10%
3. Format: Calculation and brief working or short answer for Problem 1. Calculations, explanations and a short report for Problem 2. (Excel/ Word)
4. Word Limit:  A few pages (500 words as a very rough guide; mostly calculations)
5. Due:     see Blackboard
6. The assignment must be typed in word or excel (scanned hand written answers are not acceptable).
7. Make sure to highlight or underline your final answer/s in some way. (e g Answer = $5089)
8. Upload a soft copy of your Word and/or Excel files to Blackboard under Assessment by the due date and time. Failure to upload will result in a mark of zero.
9. Assignments submitted after the due date (late assignments) cannot be uploaded to Blackboard and will receive a grade of zero as per QUT policy.
10. Please be aware that the suggested solution will be released within one day of the submission date, so no extensions will be granted for assignments in this unit.
11. Extensions will only be granted in very, very exceptional circumstances and may take the form of a different assignment. Excuses like being sick on the day the assignment is due or malfunction of computer are not considered exceptional circumstances. Students should plan ahead and take into account that last minute incidents such as these are bound to occur.
12. A hard copy is not required. Under no circumstances should you use assignment minder. Keep a copy for yourself.
13. To avoid mixing up assignments, name your assignment using the following format:

• unit code, your name, your student number, and the assignment number
• for example: EFN406 Doe John n1234567 Assignment Part A.docx

14. Finally, this cover sheet will form the first page of the document you submit. By submitting this document you are agreeing to the declarations that appear on the next page:

Answer the two problems below (P1 and P2). Five marks each. Part marks will be allocated, but if you have the incorrect answer then you cannot expect to get more than half marks.

Project 1

Polycorp is considering an investment in new plant of $3.1 million.  The project will be financed with a loan of $2,000,000 which will be repaid over the next five years in equal annual end of year instalments at a rate of 6.5 percent pa.  Assume straight-line depreciation over a five-year life, and no taxes. The projects cash flows before loan repayments and interest are shown in the table below. Cost of capital is 12.15% pa (the required rate of return on the project). A salvage value of $255,000 is expected at the end of year five and is included in the cash flows for year five below. Ignore taxes and inflation.

You are required to calculate:

1. The amount of the annual loan repayment and produce a repayment schedule.
2. NPV of the project (to the nearest dollar)
3. IRR of the project (as a percentage to two decimal places)
4. AE, the annual equivalent for the project(AE or EAV) (to the nearest dollar)
5. PB, the payback and discounted payback in years (to one decimal place)
6. ARR, the accounting rate of return (gross and net) (to two decimal places)
7. PI (present value index or profitability index) (to two decimal places)
8. Is the project acceptable? You must provide a decision or explanation for each of the methods in parts (2) to (7). Why or why not (provide a full explanation)? Also a brief explanation of your treatment of Salvage Value and Loan Repayments is required.

Project 2 Calculations must be done in Excel

Polycorp Limited Steel Division is considering a proposal to purchase a new machine to manufacture a new product for a potential three year contract.  The new machine will cost $1.5 million.  The machine has an estimated life of three years for accounting and taxation purposes. The contract will not continue beyond three years and the equipment’s estimated salvage value at the end of three years is $128,000. The tax rate is 29 percent and is payable in the year in which profit is earned.  An investment allowance of twenty five percent on the outlay is available. The after tax cost of capital is 12.85%pa. Addition net working capital of $72,000 is required immediately for current assets to support the project.  Assume that this amount is recovered in full at the end of the three year life of the project. The new product will be charged $59,500 of allocated head office administration costs each year even though head office will not actually incur any extra costs to manage the project.  This is in accordance with the firm’s policy of allocating all corporate overhead costs to divisions. Extra marketing and administration cash outflows of $68,500 per year will be incurred by the Steel Division for the project. An amount of $159,000 has been spent on a pilot study and market research for the new product.  The projections provided here are based on this work. Projected sales for the new product are 32,000 units at $133 per unit per year.  Cash operating expenses are estimated to be 75 percent of sales (excludes marketing and administration, and head office items). Except for initial outlays, assume cash flows occur at the end of each year (unless otherwise stated). Assume diminishing value depreciation for tax purposes.

Required

1. Construct a table showing your calculations of net cash flow after tax (NCFAT). Use the method shown in lectures and notes.
2. Calculate the NPV.  Is the project acceptable? Why or why not?
3. Conduct a sensitivity analysis showing how sensitive the project is to operating expenses. Explain.
4. Write a short report explaining your calculation of relevant net cash flows after tax, justifying your selection of cash flows. Be sure to state clearly any assumptions made (implicit and explicit).