Higher Education Division

FIN20014 Financial Management

Semester 2 2018

The objective of this assignment is to encourage the students to use excel spreadsheets to aid in problem solving. Students are asked to solve a capital budgeting problem using an excel spreadsheet.

For online submission on BB via Turnitin, submit ONLY ONE FILE including ONLY the Assignment Cover Page along with the copy of Formal Report.

Details of Assignment

ALLCURE Inc. has been spending in research and development (R&D) for a next generation diabetes drug since July 2017. Although the firm has spent $0.70 million for R&D during the last 14 months, it is now predicted that achieving a target result in this research may take another 6 to 8 years’ time. In the meantime, despite huge controversy, the company is planning to introduce the revolutionary pre-version of this drug, called P-REC, which might cause long-term health hazards for some patients due to unknown reasons.  Before introducing this product in the market, the Chief Financial Officer (CFO) of ALLCURE Inc. is asking for a detail analysis on PREC project.

The production line for P-REC can be started after renovating one existing section of the factory.

The project is expected to run for eight years when the targeted final version of P-REC will be ready to introduce. Required renovation can be conducted immediately at a cost of $185,000 that includes installation cost of new plant and equipment (P&E). The company has decided to capitalise total renovation costs to new P&E. The procurement of human resources (HR) required for the project will be one-off cost at the beginning and estimated to be $40,000. The project requires continuing quality assurance inspection that will cost $5,000 per month.

A local distributor of a Swedish company can immediately supply all required parts and accessories of the new P&E for a total charge of $2,550,000 including import duty of $250,000. In addition, for new P&E, transportation cost is estimated to be $65,000.  These P&E would be depreciated using a tax allowable straight line rate of 10% on prime cost. The company can sell P&E at the termination of the project for $260,000.

It is projected that sale of P-REC would be 48,000 cartons per year and that will require ALLCURE to operate at 80% of its capacity when variable operating cost will be 45% of sales.

Selling price per carton will be $60. Annual fixed operating cost, excluding depreciation, will be $470,000. It is estimated that the production line will be required to operate at full capacity after the first four years due to increasing demand. Variable operating cost at full capacity would be 40% of sales.

Existing section of the factory, where the new P&E will be installed, is in use by a subcontractor who pays monthly rent of $4,000. This rent income for ALLCURE will discontinue once the new production line P-REC will commence its operation.

It is also estimated that the new production line will require an initial increased investment of $54,000 in stock (inventory) and $23,000 in debtors (accounts receivables) that are offset by an increase in creditors (accounts payable) of $27,000. There will be no further investment in net working capital (NWC) until its final recovery at the end of project life.

The company uses required rate of return considering its weighted average cost of capital (WACC) that varies from 18 to 24 per cent in recent time. The analyst is confused about the rate to be effective for the project; however, she has decided to use 18 per cent required rate to evaluate this project. Corporate tax rate is 30%. The required discounted payback period is 5 years.

Considering probable consequences of introducing pre-version of the drug, company managers have identified another T-REC project that would be based on a safe but relatively less effective traditional treatment plan. Initial investment for this T-REC project would be the same as P-REC project and projected future cash flows would be as follows:

Year-1: $1,235,000;  Year-2: $1,186,000;  Year-3: $964,000;  Year-4: $752,000;

Year-5: $695,000;  Year-6: $670,000;  Year-7: $634,000;  Year-8: $590,000;

Before taking final decision in the upcoming meeting, the CFO of ALLCURE Inc. requires a clear explanation of all relevant issues relating to the P-REC project. Particularly a FORMAL REPORT is enquired by the CFO to include a detail analysis of cash flows and explanations of results of capital budgeting methods that are commonly used in evaluating projects. If the project is initiated, the CFO would also be interested to check whether the project would be feasible to contribute $24,000 annual expenditure for ongoing R&D activities of the firm.

Furthermore, in a separate section within the report, the CFO is interested to review a detail comparison between P-REC and T-REC projects with respect to the results of capital budgeting methods using both 18 and 24 per cent required rates, crossover rate and all relevant factors that can assist in taking final decision.

Required

Using Excel Spreadsheet, prepare a full analysis for the CFO of ALLCURE Inc. to assist in evaluating whether either project should be started or not. Your analysis should include the following

• Table of cash flows (show all digits, do not convert amounts to $ in million or thousand).
• Use of ‘excel formulae’ where appropriate (refer eLearning video of Week-6)
• A written report (1500 words, +/- 10%) outlining your recommendation as to whether ALLCURE Company should proceed with either project. Justify your recommendations using quantitative and qualitative issues and your analysis of probable risks and benefits relating to the project. Comparison statement is to be presented in a separate section in the report.

Marks will be awarded for:

• Set out of spreadsheet (watch eLearning video of week-6)
  1. Ease of reading spreadsheet
  2. Use of excel formulae in organised spreadsheet

• Correct application of theoretical model

• Overall presentation of answer including the written report.

* Carefully read the Report Format Guide (on page-5) and Marking Rubric (on page-5) for required components and presentation of formal report.

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