Reference no: EM132179212

Assessment Task - Business Finance

Task description - Assume you are a manager in the Whizz Bang Corporation Ltd (WBC), a large organisation whose business is to manufacture and wholesale spare parts for heavy transport motor vehicles. This assessment presents you with three hypothetical scenarios that you are required to respond to. You must address all three scenarios and incorporate your answers into a single cohesive report that would be suitable for submission to senior management.

Scenario 1: Capital Acquisitions

One of your team members provides you with a request seeking your approval to replace an expensive worn-out piece of equipment. As it is a replacement, very few details to support the request is provided as the staff member automatically presumes your approval. In the past, your predecessor had approved all such requests, without further information.

Required - Discuss this scenario, in particular describing what information you should require before you approve the release of capital funds for such a request, and why you would require that information.

Scenario 2: Project Proposal

You have identified a potential opportunity for WBC, which involves undertaking a project that will have a ten-year life. The project requires an initial purchase of equipment and furniture totalling $4,500,000, plus ancillary programming capability and machinery costing $1,500,000. The equipment and furniture will depreciate and have a salvage value of $500,000 at the end of the project's life, and the programing machinery will have nil salvage value at the end of the project's life. Depreciation is calculated on a straight-line basis over five years. Information related to the project is as follows:

• Sales will be $3,050,000, $4,000,000 and $5,000,000 respectively in each of the first three years of operation, expected to grow at 10 per cent per annum for a further four years thereafter, and then settle to a growth of 5 per cent per annum indefinitely thereafter. In the event of not undertaking this project, all of this income would be lost.
• Variable costs associated with the project will be 65 per cent of sales.
• Fixed costs associated with the project will be $400,000 in the first year and expected to grow at 5 per cent per annum thereafter.
• Even though this project will not add additional expenses to head office, WBC has a policy of allocating a 'head office' charge of $200,000 a year to each major project.
• Research for this project and its capability was conducted during the previous year at a cost of $300,000. It yielded valuable information.
• The corporate tax rate is 30 per cent.
• Financiers of this type and risk in this industry are presently requiring a rate of 12 per cent after corporate tax. In order to undertake this project, WBC is considering various financing options. One option is to borrowing $5,000,000 at 7 per cent per annum. This loan will be paid off in 10 equal annual instalments.

Required - Evaluate this project, and provide a report to WBC management discussing whether or not you recommend it should undertake the project, providing a full explanation of your recommendation. As support for your recommendation ensure your answer includes the following:

• Calculations of the NPV, IRR and the payback for the project and an analysis of the results.
• Justification for the correct discount rate to be used in evaluating the project.
• Your assessment of the advantages and disadvantages of each methodology (NPV, IRR and payback), and which you therefore recommend is applied to evaluate this project.
• Details of any other (financial and non-financial) matters you would consider before making a recommendation in respect of this project.

Scenario 3: Project Financing

WBC is currently financed using debt and equity with a targeted debt to equity ratio of one (D/E = 1). Its debt financing is from three sources, overdraft, bank bills and debentures, with the ratio of overdraft to bank bills to debentures of 1:2:3. Its equity is ordinary shares. These ratios represent the long-term capital structure target for WBC.

The debenture pays an annual coupon of 12 per cent per annum on its $1,000 face value. The remaining term of the debenture is six years. The debenture is currently priced $922.23.

The bank bills issued by WBC are ninety-day bills, with a face value of $100,000 and are currently priced at $97,593.58.

The bank overdraft rate is 1 per cent per annum above the bank bill rate.

The ordinary shares sell for $8.00. The projected dividend for year one is $1.10. Dividends are expected to grow at 6 per cent per annum indefinitely.

Required -

Calculate the Weighted Average Cost of Capital (WACC) for WBC, assuming a tax rate of 30 per cent. Hint: this requires a calculation of the effective annual cost for each source of finance.

Discuss whether the WACC could be used in the above project evaluation, and if so how. Include a discussion of any restrictions that apply to the use of WACC?

Evidence of Reading and Research

You need to provide evidence of researching additional relevant peer reviewed academic articles. These articles are in addition to those provided in the Managing Finance readings.