FINA1221 INTRODUCTION TO FINANCE Semester 2, 2012

TEAM ASSIGNMENT

Crawley Ltd.
Crawley Ltd. is a leading Australian producer of premium savoury snack packs. The company was founded in 1992 by George Crawley. Originally, Crawley sold his savoury snacks to petrol stations but in the early 2000s, with the caf and bar scene expanding, he expanded into hotels and restaurants. Crawleys management is currently evaluating a new savoury pack product which he hopes to develop to expand into the airline carrier market. The new product would cost more, but a new packaging technique will extend the shelf life of the product which makes it attractive to the airlines. Bo Zang is a recent UWA Business Schools graduate working at Crawley evaluating capital projects. You and your fellow team members have been asked to conduct an analysis and submit it to Bo, along with two other potential investments, to allow the companys capital expenditure committee to evaluate. Facilities for the new savoury pack would be set up in an unused section of Crawleys main plant in Osborne Park. Relatively inexpensive used machinery with an estimated cost of only $2,500,000 would be purchased from a food company in Melbourne, but shipping costs to move the machinery from Melbourne to Crawleys plant would total $200,000, and installation charges would add another $300,000 to the total cost of the equipment. Crawleys inventories (raw materials, work-inprocess, and finished goods) would have to be increased by $100,000 at the time of the initial investment. The machinery has a remaining economic life of 4 years, and the company has obtained an Australian Tax Office ruling that allows it to depreciate the equipment by 33%, 45%, 15%, and 7% in Years 1 through 4, respectively. After four years the machinery could be stripped for a salvage value of $250,000. The section of the plant where the savoury packs will be produced hasnt been used for five years and only last year, Crawley spent $1,000,000 to modernise that section of the plant. Bo Zang was in charge of that project and he believes that this cost, which has been paid just last month, should be charged to the savoury pack project. Bo believes that without the modernisation project, which he had to argue strongly for to get the company to actually commit to, the company would have to spend the $1,000,000 now to make the site suitable for the new project. Management expects to sell 2,000,000 savoury packs in each of the next 4 years, at a price of $2.00 per carton, at a cost of $1.50 per pack for fixed and variable cash operating costs. In examining the sales figures, Bo notes an email he received from the sales manager that savoury pack project would cut into Crawley Ltd.s sales of peanut packs. The sales manager estimates that peanut pack sales would fall by 5 precent if the new savoury packs were introduced. Bo has exchanged emails with the sales team, and has assessed that new project would probably lower peanut pack sales by $200,000

FINA1221 INTRODUCTION TO FINANCE Semester 2, 2012

per year, but because of renegotiated power contract, it would also reduce production costs for peanut packs by $100,000 per year. These are all before-tax estimates. Crawleys tax rate is 40 precent, and its overall cost of capital is 10 precent (after tax), reflecting the costs of debt and equity for similar risk projects prevailing in the market.

Bo has drawn up a set of questions which he requires answers to so he will submit to the capital expenditure committee. Bo has been advised that the capital expenditure committee is comprised of executives from marketing and sales who will need a clear, well supported, and jargon-free answers. The two other projects that Bo needs information on are discussed in question six and seven.

Questions
1. How should the $1,000,000 expenditure on plant modernisation, and its associated tax deduction, be included in the analysis? Explain. Nedlands Ltd. has approached management with a proposal to lease the production site for $50,000 per annum. Bo is dubious about the substance of this approach but if it were the case, how would this be incorporated into analysis? Estimate the net capital outlay and the projects estimated net cash flow stream. Assume Nedlands Ltd. didnt in fact make a formal proposal. What is the projects NPV, IRR, modified IRR (MIRR) and payback? Should the project be undertaken? Explain. (Hint: The MIRR is found in three steps: (1) compound all net operating cash inflows forward to the terminal year at the cost of capital; (2) sum the compounded cash inflows to obtain the terminal value of the inflows, and (3) find the discounted rate which forces the present value of the terminal value to equal the PV of the net investment outlays. This discount rate is defined as the MIRR. Alternatively, refer to textbook pp260 which has a different way of calculating MIRR - same answer.) There is fear that given capacity constraints in the industry, inflation is expected to average 5 percent per year over the next 4 years. i. Does it appear that the projects cash flow estimates are real or nominal? Do the cash flows appear to in constant (current year) or has inflation been included in the estimated figures? Similarly, is the 10 precent cost of capital a nominal or a real rate? Given your answer to (i), is the estimated NPV biased, and, if so, in what direction? i. There is some expectation that the sales price will increase by a 5 percent inflation rate beginning from time 0. However, operating costs are expected to increase by only 2 percent annually. Assume no other cash flows are affected by inflation. What are the projects NPV, IRR, MIRR, and payback now that inflation has been taken into account? Explain why the NPV has changed in the direction you have found. ii. What would happen to the projects NPV if inflation of 5 percent applied to both sales prices and operating costs? Explain, but do not necessarily perform the calculations.

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ii. 5.

FINA1221 INTRODUCTION TO FINANCE Semester 2, 2012

6. The second capital budgeting decision which Bo has been asked to assess and report to the committee on involves a choice of two mutually exclusive projects, Project A and Project B. A summary of the cash flows are presented below: Expected Net Cash Flow Year Project A Project B 0 ($1,000,000) ($1,000,000) 1 600,000 335,000 2 600,000 335,000 3 --335,000 4 --335,000 Both of these projects are in Crawleys main line of businesssavoury snacks and the investment which is chosen is expected to be repeated indefinitely on out into the future. Also, each project is of average risk, and hence each is assigned the 10.0 percent corporate cost of capital. i. Which project should be chosen? ii. Now assume that the cost to replicate Project A in 2 years is estimated to be $1,050,000 because of inflationary expectations and similar cost increases will occur for the project in the future (there is expected to be no inflation impact on the inflows or for project B). Would this affect your analysis? Which project should be chosen under these conditions? (hint it will change the NPVs and you need to think carefully about the calculations. This isnt a straightforward calculation. Remember that underlying the EAA approach is an assumption that the project will be replaced indefinitely with an identical project) 7. The third project to be considered involves a fleet of mobile cranes with an engineering life of 3 years (that is, the trucks will be totally worn out after 3 years). However, if the trucks were taken out of service, or abandoned, prior to the end of 3 years, they would have a positive salvage value. Here are the estimated net cash flows for each truck: Initial Investment and End-of-Year Operating Cash Flow Abandonment Cash Flow 0 ($100,000) 1 52,000 69,000 2 40,000 40,000 3 35,000 0 The relevant cost of capital is again 10 percent. What would the NPV be if the trucks were operated for the full 3 years? What if they were abandoned at the end of Year 2? At the end of Year 1? What is the economic life of the truck project? (Ignore any tax effects) Year 8. Final task to be completed Individually You must each individually answer the following question with student name and number clearly at the top of each answer and attach to the end of your assignment. YOU DO NOT SUBMIT THESE INDIVIDUALLY. Read the The Scam Wall Street Learned From the Mafia article on LMS. i) You are the CEO of an investment bank which handles similar business to the companies in the case. As CEO, and having just read the article, you feel compelled to highlight the case to your staff. Your task is to draft a suitable email to send to staff which highlights why you think the behaviour

FINA1221 INTRODUCTION TO FINANCE Semester 2, 2012

lasted for such a long time and what you consider to be the worst aspect of the behaviour of those convicted (max 120 words you must provide a word count). 120 words isnt many be succinct.

Instructions
You are strongly encouraged to use Excel Spread sheet for your calculations. Refer to LMS for Excel resources. CLEARLY SHOW THE BASIS OF YOUR CALCULATIONS. Marks Marks Qu. Assessment Criteria Available Awarded 1 2 3 4 5 6 7 Accuracy, clarity of explanation Depth of analysis, clarity of explanation Accuracy of calculations, clarity of calculations, clarity of assumptions Clarity of explanation, theoretical support Accuracy of calculations, explanation of impact Accuracy, clarity of calculations Accuracy, clarity of calculations Sub-total Presentation of work, grammar TOTAL GROUP MARK 8 Pass/Fail Pass/Fail Pass/Fail Pass/Fail Pass/Fail Total Student: Student: Student: Student: Student: 100 5 5 5 25 10 10 15 15 85 10 95

References Ensure you identify ALL references you use and use the Harvard style which you can find on the Library website at http://libguides.library.uwa.edu.au/content.php?pid=43218&hs=a

If you do not complete the first SPARK task by the required date 5 marks will be deducted from your final individual score. Failure to complete the second SPARK assessment will result in the group score being multiplied by 0.7 to provide your individual mark (unless your SPARK assessment was lower). See below for further information in relation to SPARK.

FINA1221 INTRODUCTION TO FINANCE Semester 2, 2012 SPARK https://uwa.sparkplus.com.au Peer feedback and assessment will be used to allow all group members to comment on and assess the contribution of all group members as well as themselves. To facilitate this SPARK (Self and Peer Assessment Resources Kit) will be utilised. SPARK is a tool designed to aid the development of team-skills and enhance the team experience. SPARK has been developed with the purpose to improve learning from team assessment tasks and make the assessments fairer for students. It is used to help students in a very important skill of giving and receiving feedback. By operating from a set framework of criteria, a full understanding of the attributes of your own and others work can be achieved. What will the assessment involve? There are two parts for you to complete: self and peer assessments. The program will require you to logon, complete your own self-assessment followed by evaluation of your peers. You can amend your ratings during the period specified by the instructor. Providing respectful comments for your team members in SPARK is strongly recommended. Your final team score will be weighted by the final SPA score you receive from your peers. This score will then be used to weight your team score. For example, a team scores 80% for all team tasks and two individuals in the team receive peer scores of 1.1 and 0.9. If a team member does not contribute at all it is the groups responsibility to refer this to the lecturer as they will be assigned zero if verified. Individual 1 score = 80 x 110 = 88% Individual 2 score = 80 x 90 = 72% You will complete an interim (week eight) and final assessment (week eleven). The interim assessment will not be used in the final grading but is intended to provide feedback for you and other group members which can be reflected upon and responded to during the remainder of the assignment. If you fail to complete this task, however, five marks will be deleted from your final score. The second SPARK assessment will be used in awarding individual scores from the final group assessment. To learn how to use SPARK, the SPARK registration manuals are available in LMS in the SPARK folder. More information about the use of SPARK will be explained in the lecture. If you have further queries about SPARK logins, please send an email, using subject title FINA1221 SPARK to this address: helpdesk@biz.uwa.edu.au Individuals who fail to complete the final SPARK assessment will receive a SPA score of 0.7. Objections Initially the released SPA and SAPA factors will be preliminary and only become official after any protests are considered. Any student believing their SPARK assessments were unfair may lodge an
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FINA1221 INTRODUCTION TO FINANCE Semester 2, 2012 objection. Any objection to your assessment ratings must be made in writing. Each objection must be a max of 500 words clearly outlining why you believe your rating is unfair. Your protest will be reviewed and may be discussed with the other members of your team. Objections must be lodged within 3 days from the date that the SPARKPLUS assessments are released. The lodgement of an objection will be considered as a request for reassessment of the entire team. Hence if a student lodges an objection the marks for the entire team will be reassessed and released after the objection has been considered. In considering any objection the log books and or meeting minutes for a team will be reviewed. At all times the unit coordinator retains the right to exercise discretion in relation to application of the SPA factor to the final team mark for all team members. This discretion may be exercised particularly in situations where, in the opinion of the unit coordinator, a team member(s) has / have inadvertently or intentionally, misused SPARKPLUS.

ASSIGNMENT TASKS Task 1: Register for SPARK go to https://uwa.sparkplus.com.au by Wednesday 5th September. Task 2: Complete first SPARK Task by Mon 17th September 12 noon. This will be open for you to complete on Fri 14th September. Task 3: Complete second SPARK assessment by Mon 15th October 12 noon. This will be open for you to complete on Fri 12th October. Task 4: Submission Assignment 12noon Monday 15th October, 2012. Submit your assignment in an electronic format by going to the Uniprint website www.uniprint.uwa.edu.au, then click on Submitting Student Assignments on the right hand side of the page and follow the instructions. Please remember to include both the individual answers to question 8 within the one document, clearly identifying each student. Please remember to attach an Assignment Cover sheet to the front of your assignment. You can download the relevant Assignment Cover sheet from the Business School Current Students web page: http://www.business.uwa.edu.au/students/assessments REMEMBER ALL GROUP MEMBERS SHOULD HAVE A COPY OF THE GROUP WORK COMPLETED AT ALL TIMES
For further information on working groups visit http://www.studentservices.uwa.edu.au/ss/learning/online_services/jump_start/group_work and http://www.studentservices.uwa.edu.au/__data/page/65536/Group_work.pdf for specific suggestions that will assist.