Prepare a justification of the cash flows

Assignment Help Financial Management
Reference no: EM131032457

Introduction to Financial Management

Rosanna Roses

Angelina and Brad established their business partnership 'Rosanna Roses' 5 years ago. Brad has a degree in horticulture and leaves the marketing and financing of the firm to Angelina as she has a  Commerce degree.

The business has experienced a solid level of success growing roses for the cut-flower market. It is located on a 6-hectare property north of Hobart. Five hectares are currently under cultivation and Angelina and Brad have been discussing expanding the business by utilising the spare hectare. They have asked you to analyse the following data and provide them with a recommendation as to the acceptability of the project. Brad and Angelina tell you that they will retire 10 years from today. The business will not be sold as Angelina and Brad live on the property.

Brad has been developing three new varieties of roses over the last 2 years. Development costs of the roses so far has been $70000. Details of the new roses are as follows:

  • 'Brittany' has a large flamboyant pink flower. The rose bush is sturdy and well suited to commercial growing conditions. The Brittany is well suited to the temperate climate where Rosanna Roses operates, but it is not expected to do well in warmer climates.
  • 'Taylor' has been developed for its delightful fragrance. The rose bush is not as robust as the Brittany, but is expected to perform reasonably well under commercial growing conditions. It will require a lot of pruning to prevent it turning into a monster.
  • 'Madonna' has a less exciting flower than the Brittany and a milder perfume than the Taylor, but it does have the advantage of longevity as a cut flower. It is a relatively low maintenance rose bush to cultivate.

Brad estimates that it will take 6 months for further development and testing of the new roses if the decision is made to expand the operation of Rosanna Roses with cultivation of these three roses. It would then take another 6 months to generate sufficient stock to plant a hectare of land. The operating cash outflow associated with the further development and stock production is $140000 and is tax deductible. The hectare of land that would be planted would need to be cleared, graded and cultivated. Angelina estimates that this would cost $20000. The soil would need to be enriched with 10 tonnes of manure at a cost of $100 per tonne. The clearing and fertilising costs are tax deductible. The clearing and fertilising of the land would occur the day before the new roses are taken from the green house for planting out.

The time from planting to a commercial quantity of flower buds is 3 years after the roses are transferred from the greenhouse to the soil. After the roses are transplanted from the greenhouse to the soil, the labour cost per hectare of roses under cultivation is $10000 pa, pest control will cost a further $5000 pa and the annual fertiliser    cost is $500 per hectare. Additional labour costs of $3000 pa are required when the roses are cut and packed in boxes for sale. The new project will utilise the existing cultivation equipment. This equipment was purchased 5 years ago for a total cost of $90000 and is being depreciated using the prime cost method over 10 years. It is used for all current projects.

A marketing consultant was contracted 6 months ago to provide market research on the new rose varieties.  Rosanna Roses  received an invoice for $5000 and the following advice this week.

MEMO ONE

To: Rosanna Roses

From: Brilliant Marketing

Date: 31 December 2015

Subject: Market response to the Brittany, Taylor and Madonna roses

At your request, we have conducted rigorous market research into the demand for your three new varieties of roses. Our results are as follows:

  • The large flowers and fashionable colours of the Brittany rose were well received by florists. Many commented that they had never seen a rose more suited to bridal bouquets, where the size and colour of the flowers are the critical features.
  • The fragrance of the Taylor makes this rose ideal for supermarket sales of cut flowers. Buyers for super markets commented Taylor bunches in stores would generate large sales as customers would be drawn to the stunning fragrance.
  • The Madonna rose was especially attractive to florists who specialise in funeral wreaths. The long-lasting flowers and sedate perfume of the Madonna are ideal characteristics for this market.
  • We conclude that each of the three new varieties of roses would fill market niches very successfully.
  • We have estimated how many boxes of 100 roses would be sold and the price per box for 10 years.
  • We also estimate that the new range of roses would reduce sales of your current product by $30000 per annum.
  • Initially, marketing expenses would be relatively high as we work to familiarise the market with the new roses. The charge for marketing your new products would be $20000 pa for the first 3 years of sales. The charge for subsequent years would be $4500 pa.

Y

Boxes

Price per box  ($)

1

500

200

2

700

225

3

1200

250

4

l 500

275

5

1 400

300

6

l 200

300

7

l 000

300

8

700

275

9

500

250

1

500

250

Rosanna Roses currently uses Brilliant Marketing to advertise the firm's existing range of roses. Angelina and Brad would contract Brilliant Marketing for the new project if they decide to adopt it. Brad is confident that the firm can supply as many boxes of roses as the market demands. Brad would need more greenhouse capacity to develop the new roses and grow them to the required size for planting. He has received the following quote for extending the current facilities to the size he needs.

MEMO TWO

To: Brad, Rosanna Roses

From: Glassy Greenhouses

Date:  2 January 2016

Subject:  Extension of greenhouse at Rosanna Roses

  • Thank you for asking us to provide the following quote to extend the facilities we built for you 5 years ago.
  • The expansion of the greenhouse would require a cement slab equipped with appropriate drainage. We estimate that this would cost $35 000.
  • Materials for the structure would cost $60 000
  • Labour and associated insurance will cost $12 000.

The greenhouse cannot be depreciated for taxation purposes.

In addition to the extension to the greenhouse, Brad would need racks for storing the roses while they grow. This equipment would cost $7000 and can be depreciated using the prime cost method over 3 years. A new drip watering system would also need to be installed at a cost of $6000. The watering system can be depreciated using prime cost over 4 years.

Brad recently attended a conference about future trends in the rose growing business. At one of the sessions Brad heard a leading rose market researcher discussing a change in the home gardening market for rose bushes. While 90% of current rose bush sales in the home gardening market are for bare- rooted plants about 12 months old, the researcher expects a very strong growth in the market for more mature roses in pots. Brad thinks that the Brittany, Taylor and Madonna varieties would do well in this new market. Given the different qualities of each rose, Rosanna Roses would be able to capture a large share of the potted rose market. He expects that each of the 1000 roses that would be planted on  the spare hectare of land could be  sold for $50 in 7 years from the commencement of the project. The costs of growing the roses up to this point would be the same as they are for the cut-flower market and the flowers could be sold until the rose bushes are transferred to pots for sale. The rose bushes would be harvested after flowering has finished for the year. The bushes would be presented in pots that would appeal to the upper end of the market and each pot would cost $10.

Rosanna Roses currently uses Quickest Couriers to deliver their flowers. Angelina requested a quote for freight rates and received the following from the couriers.

MEMO THREE

To: Angelina and Brad, Rosanna Roses

From:  Quickest Couriers

Date: 2 January 2016

Subject:  Quote for delivery of boxes of roses

We have received your request for a quote to expand your current delivery contract. We are pleased to be able to continue to offer you the fixed rate of $25 per box. The delivery price for potted roses will be $4 per pot. We look forward expanding our happy business relationship with Rosanna Roses.

Angelina has provided the following information about the firm's cost of capital:

  • The before-tax cost of capital is 15.25%.
  • The after-tax cost of capital is 10.75%.
  • The rate of return on Treasury Bills is 6.5%.
  • The company's after-tax cost of debt is 8%.

New projects with similar risks as existing projects are evaluated at the cost of capital. Any new projects that have different characteristics to the current Rosanna Roses projects (that is, those that do not involve growing roses) would be evaluated using a risk-adjusted discount rate. A further 7% would be added to the cost of capital for projects that do not involve growing roses. Brad and Angelina both have a marginal tax rate of 42%. The corporate tax rate is 30%.

Assume that any tax losses from this project can be used to offset tax payable on other operations conducted by Rosanna Roses.

Angelina and Brad have asked to you advise them on the acceptability of the project.

They have requested that you use the NPV and IRR approaches.

REQUIRED-

1.  Advise Angelina and Brad on their decision about accepting or rejecting the project. Show all equations and calculations.               

2. To support your calculations in (1), prepare a justification of the cash flows you have used in your analysis. That is, you should identify why you have included each cash inflow and outflow to arrive at your net cash flows. If you have omitted cash flows discussed in the information provided, you should also explain why these have not been used in the analysis.

3. Justify your choice of discount rate for the analysis.   

4. Currently, Rosanna Roses is structured as a partnership. Brad and Angelina are thinking about listing the firm on the ASX if this project is successful.

They have asked you to explain the impact (if any) that listing would have on the capital budgeting process. Write a short essay to advise them on this matter. (300 words)            

5. Include a reworked analysis of the project (that is, repeat requirement 1) assuming Rosanna Roses is structured as a company that is fully integrated with the dividend imputation system. Show all calculations.

Reference no: EM131032457

Questions Cloud

Validate user information : Create 2 web pages that does the following: 1) Page 1: HTML Page that contains a form that collect information from user and pass it on to the next page. a) You need to validate user information (String, number, email,..)
Problem regarding the casting aluminum : Problem: In casting metal parts, molten metal flows through a "gate" into a die that shapes the part. The gate velocity (the speed at which metal is forced through the gate) plays a critical role in die casting
Compare and contrast three scripting languages : Students will compare and contrast three scripting languages, the approaches, and techniques used in each to facilitate interactive design.
What is crocs current product flow process : How does the company collaborate with suppliers and retailers during this new product development process, and why is this important for effective and efficient product design?
Prepare a justification of the cash flows : To support your calculations in (1), prepare a justification of the cash flows you have used in your analysis. That is, you should identify why you have included each cash inflow and outflow to arrive at your net cash flows
Write a paper about why nelson mandla was a good leader : Write a two pages paper about why Nelson Mandla was a good leader? and what he did? The paper must be in double space.
What are the 10 most important things : What are the 10 most important things I need to know about learning The basics of C++ ?
Write the document''s topic as the document''s header : Write the document's topic as the document's header. On the document's first page, insert a list of the document's paragraph names. The paragraph names briefly describe the paragraphs' contents. Add a hard page break to the first page to make sure th..
Prey attract predators : Here is one way in which nature regulates the size of animal populations: high population density attracts predators, who remove a higher proportion of the population than when the density of the prey is low.

Reviews

Write a Review

 

Financial Management Questions & Answers

  Contribution to funds performance during that period

Can fund holdings in a sector that underperforms the index during the relevant period make a positive total contribution to a fund’s performance during that period? How? Also, If you are worried about a sharp decline in the stock market, would you ge..

  Job with an unusual bonus structure

You have been offered a job with an unusual bonus structure. As long as you stay with the firm, you will get extra 70, 000 every seven years, starting seven years from now. What is the present value of this incentive if you plan to work for the compa..

  Begin by constructing time line

A project has an initial cost of $63,700, expected net cash inflows of $11,000 per year for 11 years, and a cost of capital of 12%. What is the project's NPV? (Hint: Begin by constructing a time line.) Do not round your intermediate calculations. Rou..

  What is the drop in value of share of summit system stock

Summit system has an equity cost of capital of 11%, will pay a dividend of $1.5 in one year and its dividends had been expected to grow by 6% per year. You read in the paper that summit has revised its growth prospects and now expects its dividends t..

  Exchange rates and market rates

What do you call a check that a bank writes on its own account made payable to a third party on your behalf? The FDIC and NCUA insure non-retirement accounts in banks, savings & and loans, and credit unions for up to: Assume the following exchange ra..

  Firms inventory carrying cost is equal

Aberwald Corporation expects to order 126,000 memory chips for inventory during the coming year, and it will use this inventory at a constant rate. Fixed ordering costs are $300 per order; the purchase price per chip is $20; and the firm's inventory ..

  Value of ending inventory using variable costing

Watkins Inc Income Statement For the Year ended December 31, 2010 Sales (@ $50) 250,000 COGS 120,000 Gross Margin 130,000 Less selling & admin Variable selling 75,000 Fixed selling 10,000 Fixed admin exp 15,000 100,000 Net Income $30,000 Watkins manu..

  The writer of a call option

The writer of a call option has

  Perform multiple regression with real financial data

Perform multiple regression with real financial data - estimate the Fama - French 3-factor model for a list of twenty stocks and interpret the regression output.

  Discuss the role of a third party intermediary

Discuss the role of a third party intermediary in an interest rate swap agreement. Describe the risks assumed by the intermediary. How does the intermediary potentially profit from this activity?

  Assume the market is in equilibrium with required return

Simpkins Corporation does not pay any dividends because it is expanding rapidly and needs to retain all of its earnings. However, investors expect Simpkins to begin paying dividends, with the first dividend of $1.50 coming 3 years from today. what is..

  Market risk premium-required return on genetics stock

Wendy purchased 800 shares of Robotics Stock at $3 per share on 1/1/09. Wendy sold the shares on 12/31/09 for $3.45. Genetics stock has a beta of 1.3, the risk-free rate of return is 3%, and the market risk premium is 8%. The required return on Genet..

Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd