• March 8th, 2016

Strategic Corporate Finance for CarMaker Ltd

Paper, Order, or Assignment Requirements

 

Introduction

You work at the headquarters of CarMaker Ltd. and are responsible for the evaluation of capital investment projects. The business is currently trying to decide between 2 proposed manufacturing plants in Yorkshire. Each manufacturing plant has an expected life of 10 years but one is a larger investment. At the end of the 10 years the small plant will be sold for £1.8 million and the large plant for £6.5million.

 

Revenue and costs

Revenue will come from selling the cars in the European market. The revenue per car is expected to be £12,000 for the small plant and £10,000 for the large plant over the time period being examined.

 

The manufacturing plants are expected to produce the following number of cars per year.

 

Small plant: 500 cars in year 1, 1,000 for the remaining years.

Large plant: 500 cars in year 1, 2,200 in years 2 and 10, and 5,000 for the remaining years.

 

The investment will be financed through a loan from Yorkshire Bank.

 

Below is the accountant’s list of costs associated with each project and timing of payments.

 

Summary of costs (and year in which cash flow occurs) Small Large
Investment costs £’000 £’000
Preparatory costs (planning, legal etc) 100 1000
Land Purchase Cost  (year 0) 28,000 100,000
Total Interest expense 372 744
Equipment (year 1) 16,070 58,035
Grid connection (year 0) 500 500
Refurbishment of Equipment (year 5) 7000 19,000
  52,042 179,279
Less government grant 600 100
Net capital cost 51,442 179,179

 

The accountant has prepared the following forecast profit and loss accounts for the life of the projects.

 

Small Manufacturing Plant: projected profit and loss accounts (£’000)
Year 1 2 3 4 5 6 to 9 10
Sales 6,000 12,000 12,000 12,000 12,000 12,000 12,000
Government grant 60 60 60 60 60 60 60
Total revenue 6,060 12,060 12,060 12,060 12,060 12,060 12,060
Annual operating costs              
Insurance 250 250 250 250 250 250 250
Business rates 50 50 50 50 50 50 50
Wages 750 750 750 750 750 750 750
Annual management fee 25 25 25 25 25 25 25
Other Annual Running costs 390 390 390 390 390 390 390
Interest expense 100 90 74 48 30 20 10
Depreciation 1,607 1,607 1,607 1,607 1,607 1,607 1,607
  3,172 3,162 3,146 3,120 3,102 3,092 3,082
               
Profit/(loss) 2,888 8,898 8,914 8,940 8,958 8,968 8,978
               
Large Manufacturing Plant: projected profit and loss accounts (£’000)
Year 1 2 3 4 5 6 to 9 10
Sales 5,000 22,000 50,000 50,000 50,000 50,000 22,000
Government grant 10 10 10 10 10 10 10
Total revenue 5,010 22,010 50,010 50,010 50,010 50,010 22,010
Annual operating costs              
insurance 900 900 900 900 900 900 900
Business rates 100 100 100 100 100 100 100
Wages 2,400 2,400 2,400 2,400 2,400 2,400 2,400
Annual management fee 95 95 95 95 95 95 95
Other Annual Running costs 1,580 1,580 1,580 1,580 1,580 1,580 1,580
Interest Expense 200 180 148 96 60 40 20
Depreciation 5,804 5,804 5,804 5,804 5,804 5,804 5,804
  11,079 11,059 11,027 10,975 10,939 10,919 10,899
               
Profit/(loss) -6,069 10,952 38,984 39,036 39,072 39,092 11,112

 

 
Further information

The following information is also available

 

a)    Payments and receipts arise at the year ends unless otherwise stated

b)    The project is expected to have an anticipated life of 10 years.

c)    All costs and revenues are expressed at today’s prices (year zero) with no allowance for inflation.

d)    The government grant will be received in year 0. However it has been spread over the life of the project in the profit and loss accounts

e)    The preparatory costs have already been incurred.

f)     The annual management fees for both projects include a fee of £15,000 which is an apportionment of head office overheads.

g)    The refurbishments in year 5 require the use of specialised equipment that will be borrowed from another division of the Company. This will cost the other division additional hire costs of £100,000 per project and is not reflected in the profit and loss accounts

h)    An initial cash reserve is needed for each project. It will be paid back at the end of year 10.

o   Small £1.5 million

o   Large £2  million

i)      Ignore corporation tax.

j)      The CarMaker Ltd. has a cost of capital (discount rate) of 12%.

k)    They have a current return on capital employed of 15% and this is expected to be met by new projects.

l)      They expect projects to have a payback period of no more than 5 years.

 

Required:

 

Task 1 Calculations (using the spreadsheet)

a)    Enter relevant figures into the cash flows worksheet and justify any adjustments to the profit and loss accounts as a result of the information in points a)-l) above.

b)    Using the figures in the calculations worksheet for Net present value (NPV), Internal Rate of Return (IRR), accounting rate of return (ARR) and Payback Period, state, with reasons which project you would accept.

c)    Use the sensitivity worksheet to prepare a sensitivity analysis for each project by adjusting each variable +/- 10%.

 

Use the spreadsheet provided to enable you to undertake all necessary calculations. You must use this spreadsheet.

(40 marks)

Task 2 Risk

You are not expected to do any calculations for this task.

·         Evaluate these projects using your sensitivity analysis.

·         Discuss how using expected values could help analyse the projects.

·         Should CarMaker Ltd.  take account of inflation in their analysis of the two plants?

 

Credit will be given in this task for appropriate use of academic literature along with accurate citations and referencing using the Harvard system.

(60 marks)

 

 

Additional Information
 

Methods of working

You are expected to the use the assignment 1 spreadsheet for your calculations. This should be uploaded to Moodle along with your written work.

 

Assignment 1 spreadsheet

There are 4 worksheets in this workbook to help you with your assignment (cash flows, calculations, sensitivity worksheet and sensitivity answers).

 

Cash flows worksheet:

Enter all cash flows and a discount rate. Use this information to calculate the present value of each year’s cashflows.

 

Calculations worksheet: Use the cells provided to calculate the NPV, IRR, ARR and Payback period for each project.

 

Sensitivity worksheet: Use this worksheet to adjust the different variables by +/- 10% and see the effect on the NPV and IRR. See seminar examples of how to work with this tab.

 

Sensitivity answers

Enter your answers to the sensitivity analysis in the lighter shaded cells.

 

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