Finance Assignment 3

Question 1: Capital Budgeting Task (18 marks total) 

You are helping Initech with its capital budgeting decisions. The company is a producer and wholesaler of  electronic parts, has a 14% cost of capital and is subject to a 30% tax rate. There are two major proposals on  which Initech would like your advice.  

1. The device part project  

Initech is considering whether it should expand into production of a part for a new generation of mobile  devices. Trends suggest these devices and their parts will offer high growth in the early years of a 5-year life  cycle.  

The new plant and equipment needed to produce the part will cost $800,000, which the business will  depreciate for tax purposes using a prime cost rate of 10% per annum. When the project is wound up at the  end of five years, the general purpose equipment is expected to be sold for an estimated $200,000.  

Sales in the first year are expected to be $4,000,000, increasing at a high rate of 10% in the second and third  years and then falling by 15% per year for the last two years of the project as demand declines due to competing new technologies. Consultants called in previously by Initech, who were paid $75,000 in fees,  estimated that variable costs for the project will be 50% of its revenues.  

Building rental, fixed salaries and other fixed costs directly related to the project are expected to be  $1,500,000 in the first year and increase by 2% per year thereafter. The investment in net operating working  capital related to the project is expected to be 10% of the following year's sales revenues. This investment  will be recovered by the end of the project. It is also thought that the project will encourage additional after  tax profits of $150,000 per year for Initechs' existing part range.  

2. The conveyer system  

Initech needs to install a conveyer system as soon as possible because the existing system, which has no scrap  value, is beyond repair. Three different systems are being considered. The first, System A, is the same type  of system as the old one – just a newer model. It will last 10 years and cost $40,000 to purchase and install.  The second, System B, will last 10 years and cost $55,000 to purchase and install. The third, System C, will  last 20 years and cost $130,000 to purchase and install. None of the systems will have any expected salvage  value but all will be replaced at the end of their lives. After examining all costs, the net cash outflows for  each system are: $13,000 per year for System A; $9,000 per year for System B; and $1,400 per year for  System C.  

Requirements and marking criteria  

Provide Initech with a memo that provides your recommendations on the two proposals. Your memo should  also include details of your analysis and briefly explain and justify your chosen methods and any assumptions  made. Table format for presenting figures is preferable.  

Twelve marks will be allocated to analysis of the device part project and six marks to analysis of the conveyer  system. Marks for each will be awarded for demonstrated understanding of the issues through: justification  of chosen analytical techniques, correct application of those techniques, and appropriate and insightful  conclusions and recommendations.  

Question 2: Company analysis (9 marks total)  

For this question you are required to further analyse the ASX listed company assigned to you for Assignment  2.  

1. a) Briefly describe a likely 'average' risk capital budgeting project for the company. Consider its possible  life, cash flow pattern and investment size relative to the company. Also hypothesise the variables to which  NPV might be most sensitive and would therefore need the most focus in project analysis. No quantitative  analysis is needed to answer this question. Focus on qualitative factors. If the company has several business  divisions, choose one for this question. (3 marks)  
2. b) Assess the working capital management of your assigned company, focusing on its cash conversion cycle  for each of the 30 June 2015 and 30 June 2016 financial years. Incorporate the company's context within  your evaluation and compare with a competitor or other relevant benchmark. As in Assignment 2, use  DatAnalysis to access your assigned company's financial data.1 (6 marks)  

Question 3: Short-term financing (3 marks total)  

No additional research or data is necessary in answering this question. Simply apply your knowledge from  the unit learning materials.  

In its 2016 Annual Report, Telstra Corporation Limited stated that (p. 112):  

Our commercial paper is used principally to support working capital and short term liquidity.  a) What does the use of commercial paper suggest about the credit risk of Telstra? (1 mark)  

1. b) What asset financing policy does the quote above suggest Telstra may follow? Justify your answer and  outline the benefits of that policy in comparison with alternative policies. (2 marks)  

Question 1: Capital Budgeting Task

Memorandum

To:  Initech

From: XXX

Subject: Analysis of proposals for the device part project and the conveyor system project

Dear Sir/Madam,

We offer our sincere gratitude for your association with us as part of this major investment initiative. As requested, our consultants have evaluated the proposed projects for business expansion and plant improvements. Based on our analysis, we have arrived at the following conclusion.

1. The analysis of the proposed business expansion with the set up of device part production unit has revealed that it is optimistic and is expected to generate value for the organisation.
2. The three options of conveyor systems are analysed, and the results reveal that System B is suitable as it has minimal cash outflow when compared to other systems and that the existing system is to be replaced immediately with a new conveyor system 
3. We recommend that Initech undertake the device part production project as part of business expansion and the System B conveyer system project to carry out business operations effectively. 

The following sections show the methodology adopted to evaluate the feasibility of the proposed projects. The first part deals with the device part project and the second section discusses the conveyor system project. Finally, recommendations of our team and conclusion are summarised.