FIN80005 Corporate Financial Management - Individual Assignment
Semester 1, 2018
The objective of this assignment is to encourage students to use Excel spread sheets to aid in solving a capital budgeting problem. Topics 4 - 8 are particularly relevant for this assignment. Weight: 20% of total assessment
Due dates: Due in the corresponding classes in the week beginning May 14. You must contact your lecturer directly and make alternative arrangements should you not be able to submit your assignment in class. In addition, the electronic version must be submitted via Turnitin on Blackboard prior to your class in the week beginning May 14.
Late submissions: Late assignments cannot be accepted unless a time extension has been re- quested from, and approved by, the Unit Convenor. Such requests must be made in writing via email.
Format: This assignment is a problem solving exercise, using Excel spreadsheets, with discussion of findings. It should be written in a report format. The length of the report is XXXXXXXXXX,500 words. Report writing resources are provided under Assessments on Blackboard.
1
Company background
Branson ltd is a public listed tour company that is based in Melbourne. One of its main operating businesses is to provide tourists with hot-air balloon flights over the city. As their current balloons are due to be retired, they must decide whether to replace them with a large or small model. New balloons have an expected life of 8 years, after which salvage values are $50,000 for the large balloons and $30,000 for the small balloons. Market research has estimated that there is a 50% probability that demand will be high throughout the useful life of the balloons, a 25% probability that demand will be high in the first four years and low in the final four years, and a 25% probability that demand will be low throughout the useful life of the balloons.
The large model is expected to cost $800,000, with an extra installation and shipping costs of $50,000. The small model is expected to cost $500,000, with an additional installation and shipping costs of $30,000. The company accounting’s policy is to depreciate using the reducing balance approach of 20% per annum.1 There is also an initial increase in net working capital of $50,000 for the large model, and $30,000 for the small model. The net working capital is recoverable at the end of their useful life.
In the event of high demand, the company expects a yearly operating revenue of $650,000 for the large model, and a yearly operating revenue of $300,000 for the small model. If the demand is low, yearly operating revenue is forecasted to be $300,000 for the large model and $150,000 for the small model. Annual variable and fixed costs associated with operating these balloons are expected to be $300,000 for the large model and $120,000 for the small model. In addition, if the large model is preferred over the small model, the company needs to rent an additional warehouse to store the large balloons. A new warehouse’s rental cost is expected to be $50,000 per year. At any given time in the first four years, there is also an option to cease operation and thus selling the large balloons for $400,000 and the small balloons for $80,000 if the business is not profitable.
The company requires you to calculate an appropriate discount rate using the company’s weighted average cost of capital. The company’s capital structure has remained fairly stable, with a debt-to-equity ratio of 1.5. The company has no plan to adjust its capital structure in
1 As discussed in Topic 5, ignore residual value in the calculation of yearly depreciation.
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the future. Given that the company is listed on the stock exchange, you are able to obtain the historical returns over the last 20 years for the company, the market portfolio and the risk-free rate as tabulated in Table 1. The company debentures have a face value of $1000 and a coupon rate of 10%. They mature in 5 years time. Similar debentures are currently yielding 12%. The company tax rate is 30%.
Table 1 Historical yearly returns for Branson ltd, market and risk-free bond Year Branson Market Risk-free
XXXXXXXXXX XXXXXXXXXX XXXXXXXXXX XXXXXXXXXX XXXXXXXXXX
5.64% 10.43% 23.13% 13.81% 19.55% 12.77% 10.08% 7.65%
-19.35% -10.64% 25.01% 14.61% 29.21% 29.48% 28.41% 23.83% 22.29% 20.93% -5.68% 1.73%
-68.09% -33.58% 48.21% 33.84% 12.39% 8.03% -6.54% -6.43% 15.28% 18.56% -1.12% 10.38% 17.98% 11.67%
-15.44% -6.43% 26.23% 16.29% 0.20% 5.70%
5.49% 6.01% 6.31% 5.62% 5.84% 5.37% 5.59% 5.34% 5.59% 5.99% 5.82% 5.04% 5.37% 4.88% 3.38% 3.70% 3.66% 2.71% 2.34% 2.72%
Required
You are to prepare spreadsheets, to present to the CEO, showing the various cash flows based on the different scenarios. Use Excel to prepare a full analysis, evaluating whether or not the company should proceed with the purchase of large or small balloons, taking into consideration of the various scenarios. Show all formulae, adjacent to the corresponding calculated amounts in the spread sheet. You should also clearly state any assumptions (if any) made in your analysis.