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- 1. 1 Photocopy this cover and attach it to the front of your submission for this subject. UTS: Business School Finance Discipline Group 25742 Financial Management Case Study Spring Semester 2015 Due: In your lecture during the week commencing 05/10/15 or by 5pm Monday, 12/10/15 in the box marked ‘FINANCE 2’ in the student lounge on level 5 in Building 8 (in front of the blue pods), UTS. Student Surname Student First Name Student No. Lecturer Or day & Time 1.Ngo Thao 12412021 Wed 3-6pm 2. Chhay Joshua 10276374 Thurs 6-9pm 3. Teodoro Rommel 10714398 Wed 3-6pm 4.Lui Yang 11668074 Wed 3-6pm Marking Feedback Item Marks awarded Spreadsheet – total marks out of 14 Initial cash flows Annual cash flows Final year only cash flows NPV and uncertainty analysis Spreadsheet easy to read and understand Executive Summary – total marks out of 6 Problem definition Aims and objectives Methods Key findings Conclusions and recommendations Executive summary expressed clearly TOTAL marks out of 20
- 2. 2 EXECUTIVE SUMMARY Problem Definition All Over Fitness Limited (AOF) is a company that provides fitness equipment for gymnasiums and fitness organisations in Sydney. Currently, it is considering to open a new office in Melbourne. The company has considered the initial cost involved, forecasted revenue growth, and financed the project. Without financial analysis, however, AOF cannot be sure if the new Melbourne office will bring profits for the company. Aims and objectives Our aim is to conduct financial analysis and determine whether or not AOF should take on the project in Melbourne. This task includes calculating intial cash outlay and annual cash flows over the life of the project. AOF has already conducted market research and predicted many metrics. From these, the relevant and necessary information must be identified and used to calculate annual earnings, a proper discount rate for the project, NPV, and uncertainty of predictions. Method To make an effective investment decision, the first step is to identify the relevant cash flows and disregard any irrelevant information. Research cost of $230,000 spent by AOF and $10,000 expense costs allocated to Melbourne represents sunk costs, thus are not included in the analysis. An interest expense of $10,050,000; a $10,000,000 loan and payment of $1,097,946.25 p.a. in principal and interest represent financing costs. They are not relevant in calculating operating cash flow. Next, the initial cash outlays associated with launching of the project need to be identified. This includes $10,080,000 spent on equipment and installation and $450,000 spent on marketing cost. Training cost for six staff members is $90,000 and brings a 30% tax advantage of $27,000. Change in net working capital is calculated to be $150,000. The initial cash out flow totals $(10,743,000). The third step is to calculate annual cash flows over the life of the project. This includes transportation costs of $(120,000) p.a. that will be constant for the duration of the project. Depreciation of machinery over 5 years equals $2,000,000 p.a. Salaries of 3 manufacturing staff are $225,000, together with salaries of administrative staff $120,000 p.a. and salary of sales staff of $80,000 p.a., totalling $425,000 p.a. for the life of the project. Revenue increases from the Melbourne project vary from year to year, while estimated reduced sales in Sydney is $1,250,000 p.a. Other variable cash flows over the life of the project included electricity and marketing costs. Additional working capital is calculated by 5% of the following year revenue increase, represented in the spreadsheet. The following step is to identify cash flow at the end of the project. This includes sale of machinery of $850,000, with negative tax effect of the salvage machinery of $255,000. Together with operating cash flow, the final cash flow is $2,669,375.
- 3. 3 The final step is to determine Net Present Value. Because the risk of the project is 100% equity, we ignore loan interest and payments and only use CAPM to calculate discount rate. Utilising CAPM with the information provided, the discount rate is 10.28% (4.5% + 0.825*7% = 10.28%). Using this interest rate to discount annual cash flows, NPV is calculated to be $82,323.46. To assess the risk of our forecast, we conduct uncertainty analysis using revenue growth rate and net working capital growth rate as variables. We use Data analysis function in Excel to test different scenarios. With revenue growth rate and net working capital rate ranging from 1% to 8%, we are able to see how sensitive our predictions are to respective variables. Key Findings The initial cash outflow in Year 0 is -$10,743,000. The final cash flow in Year 10 is $2,699,375. Using CAPM, the appropriate discount rate for the project is 10.28%. The NPV of the project is $82,323.46. The NPV is positive over the life of the project, thus AOF should accept this project and open a new office in Melbourne. Currently, AOF predicts that revenue will increase by 5% from Yr 3-Yr 5. In uncertainty analysis, we test different scenarios of growth rate from 1% to 8%. Revenue growth rate 1% 2% 3% 4% 5% 6% 7% 8% NPV -1,189,368 - 879,512 - 564,311 - 243,715 82,323 413,854 750,925 1,093,585 Here we can see that if revenue growth rate is only 4%, the project’s NPV would decrease significantly to a negative value. NPV is very sensitive to revenue growth rate and the risk is high. The spreadsheet includes details of sensitivity analysis for net working capital and graphs. Conclusions and Recommendations We recommend that All Over Fitness Limited accept the project. The recommendation is based positive NPV over the project’s life after discounting future cash flows at appropriate discount rate. AOF also needs to keep in mind that even though NPV is positive, NPV is sensitive to revenue growth rate and the risk in this forecast is high. A cost that we believe should be monitored is the increasing electricity charge. Whilst the revenue is increasing by 5% in Yrs 3-5, the electricity cost increase from year five year 10; by 6.7%. Although this is taking into account the inflation for the period, it is relatively large increase that should be continually examined. A further profit that could be made by All Over Fitness Limited is the sale of the old machine equipment at the end of the project (end of year 10). The expected profit is to be $595,000 after tax.
- 4. Team Leader Amy Ngo 12412021 Tutor's Name Tutorial time Wed 3-6 Cash Flow at Start Year 0 Year 1 Year 2 Year 3 Training cost for new staff (6) -$90,000 Tax effect of training cost $27,000 Marketing cost -$450,000 10276374 Joshua Chhay Machinery -$10,000,000 10714398 Rommel Teodoro Installation -$80,000 11668074 Yang Lui Net working capital -$150,000 Total year 0 -$10,743,000 Variables Sale growth rate 5% Cash Flows over the life Revenue $3,000,000 $4,000,000 $4,200,000 Depreciation (5 yrs) -$2,000,000 -$2,000,000 -$2,000,000 Electricity Costs -$150,000 -$150,000 -$150,000 Marketing Costs -$450,000 -$450,000 -$450,000 Staff wages (75k for 3, 60k for 2, 80k) -$425,000 -$425,000 -$425,000 Reduced sales in Sydney -$1,250,000 -$1,250,000 -$1,250,000 Transport (incl.insurance) -$120,000 -$120,000 -$120,000 EBIT -$1,395,000 -$395,000 -$195,000 Less Tax at 30 % (Tax savings on loss) $418,500 $118,500 $58,500 Add: Depreciation $2,000,000 $2,000,000 $2,000,000 Net working capital -$50,000 -$10,000 -$10,500 Total $973,500 $1,713,500 $1,853,000 Cash Flows at the End Sale of Machinery Tax effect on salvage value at 30% Total tax effect of sale of machinery Total for year 10 NPV $82,323.46 Discount rate 10.28% Accept the project as NPV is positive Change in Net Working Capital Growth rate 5% Year 0 1 2 3 Working capital in 150,000-$ 200,000-$ 210,000-$ 220,500-$ Working capital out 150,000$ 200,000$ 210,000$ Change in NWC 150,000-$ 50,000-$ 10,000-$ 10,500-$
- 5. CAPM 4.5%+0.825*7% = 10.28% Sensitivity analysis NPV Variable $82,323.46 Sale growth rate 1% 1,189,368.07-$ 2% 879,512.22-$ 3% 564,310.83-$ 4% 243,715.18-$ 5% 82,323.46$ 6% 413,853.81$ 7% 750,924.58$ 8% 1,093,584.51$ -$1,500,000.00 -$1,000,000.00 -$500,000.00 $- $500,000.00 $1,000,000.00 $1,500,000.00 1% 2% 3% 4% 5% 6% 7% 8% NPV Sale growth rate Sensitivity analysis NPV
- 6. Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 $4,410,000 $4,630,500 $4,630,500 $4,630,500 $4,630,500 $4,630,500 $4,630,500 -$2,000,000 -$2,000,000 -$150,000 -$160,000 -$160,000 -$160,000 -$160,000 -$160,000 -$160,000 -$250,000 -$250,000 -$250,000 -$250,000 -$250,000 -$250,000 -$425,000 -$425,000 -$425,000 -$425,000 -$425,000 -$425,000 -$425,000 -$1,250,000 -$1,250,000 -$1,250,000 -$1,250,000 -$1,250,000 -$1,250,000 -$1,250,000 -$120,000 -$120,000 -$120,000 -$120,000 -$120,000 -$120,000 -$120,000 $215,000 $425,500 $2,425,500 $2,425,500 $2,425,500 $2,425,500 $2,675,500 -$64,500 -$127,650 -$727,650 -$727,650 -$727,650 -$727,650 -$802,650 $2,000,000 $2,000,000 -$11,025 $0 $0 $0 $0 $0 $231,525 $2,139,475 $2,297,850 $1,697,850 $1,697,850 $1,697,850 $1,697,850 $2,104,375 $850,000 -$255,000 $595,000 $2,699,375 4 5 6 7 8 9 10 231,525-$ 231,525-$ 231,525-$ 231,525-$ 231,525-$ 231,525-$ 220,500$ 231,525$ 231,525$ 231,525$ 231,525$ 231,525$ 231,525$ 11,025-$ -$ -$ -$ -$ -$ 231,525$
- 7. Sensitivity analysis NPV Variable $82,323.46 Working capital 1% $187,753.94 growth rate 2% $161,396.32 3% $135,038.70 4% $108,681.08 5% $82,323.46 6% $55,965.84 7% $29,608.22 8% $3,250.60 $0.00 $50,000.00 $100,000.00 $150,000.00 $200,000.00 1% 2% 3% 4% 5% 6% 7% 8% NPV Working capital change Sensitivity analysis NPV