Assignment Problem: The assignment consists of two individual practical tasks where students are required to apply capital budgeting techniques and perform a risk analysis on a project. The timed assignment will be available on the course site for a specified period only.
Assignment Task 1: Natural Amalgamated
Role and Context: You are a financial analyst in the capital projects department of Natural Amalgamated Chemicals (NAC), a specialty chemicals producer of fire-control substances, additives, and pesticides based in Queensland. NAC is currently considering these two possible projects, both of which will be used to manufacture furfural (an organic compound derived from agricultural by- products) and furfural-based derivatives to make resins, urethanes, and refining solvents over a 10- year operating period. Currently, NAC is small in scale and cannot take both projects, however the management is eager to embark on a rapid expansion and modernization program.
The second project, the Mackay Plant, is a modification of an existing plant NAC already owns in the city of the same name in north Queensland. The Mackay Plant has been idle for many years, but with renovation would be well suited to furfural production. If not used for the proposed project, NAC will lease out the existing plant for $60,000 after tax per year. The estimated development and construction costs are $15 million this year in 2020, alongside with the investment in plant and equipment of $5 million. NAC will again need to invest in working capital. The change in net working capital is 4% of sales every year. Sales will be $45 million in 2021, the first year of production, increasing by 7% per annum thereafter. Given the relative geographic isolation of the plant and the stricter environmental controls given the proximity to the Great Barrier Reef, the cost of goods sold is 75% of sales. Fixed costs are $5 million in 2021, increasing by 4% per year. The buildings and plant/equipment will again be depreciated straight line to zero over the 10-year project life. The renovated buildings will have no salvage value and the plant and equipment have 20% salvage value. At the end of the project, the Mackay Plant will revert to being idle awaiting potential future developments at no cost. The company tax rate in Australia is 30%.
Task:
Briefly outline the benefits/limitations of each project and recommend to NAC's CFO, Ms. Alexandra Robinson, whether NAC should invest in these projects, if any. Your recommendation should be supported by appropriate calculations. Assume NAC has a cost of capital of 12% for domestic projects and 15% for international projects.
Assignment Task 2: Smart Water
Role and Context: You are a newly hired financial analyst with Smart Water Group (SWG), a company operating in most states of Australia, which specializes in bottling purified water sourced from local water springs. SWG is considering adding to its product mix a 'healthy' bottled vitamin water geared towards children, aimed at improving both its business focus and the return to shareholders.
Task:
Question 1: The CEO and CFO have decided to rely on your newfound expertise as to recommendation on the appropriate discount rate to be used in evaluation of the new project.
Question 2: Concerned about the forecasting risk of this project, they also ask that you perform a risk evaluation on the base case NPV in the form of: - Sensitivity analysis for sales price, variable costs, fixed costs and unit sales at ±10%, ±20%, and ±30% from the base case, showing on a graph which variables are most sensitive; - Scenario analysis on the following two scenarios:
Part 1: Worst Case: selling 925,000 units at a price of $1.80 and variable cost of $0.65 per unit;
Part 2: Best Case: selling 1,550,000 units at a price of $2.25 and variable costs of $0.49 per unit.
Question 3: Finally, advise the CEO and CFO whether this project is an acceptable investment taking in consideration the capital budgeting technique used and the risk analysis performed.
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