Details of Assignment
The Chief Financial Manager (CFO) of ALLPURE Corporation needs a detail analysis on an adventurous proposal to introduce a new line of cleaning products, which requires an extension of a new wing of production and supply chain. The project acceptance will cease operations on low margin existing dairy products. Employees working on dairy products line would be trained up to work for cleaning products line.
Existing plant and equipment (P&E) of dairy products line need to be replaced by new P&E of cleaning products line. The company invested $1,275,000 six years ago for existing P&E, which can be sold currently for $360,000 before taxes. These are being depreciated for tax purposes using the straight-line rate of 8% and having a remaining useful life of six years with an expected end of life market value of $70,000. All required parts and accessories of the new P&E will be supplied by a firm from Germany for a cost of $1,860,000 including transportation cost of $50,000. In addition, import duty of $225,000 and installation costs of $320,000 are to be incurred for new P&E. These P&E would be depreciated for tax purposes over its useful life of six years using the straight line rate of 15%. The new P&E can be sold for $480,000 at the end of its useful life. In understanding the prospect of new cleaning products line, ALLPURE has spent $45,000 for conducting a recent market survey. The survey report has proposed to distribute free samples of $50,000 at the beginning for consumer awareness.
Overall operating costs would be re-structured due to the replacement of product line and it’s expected to reduce overall operating costs by $225,000 per year. The operating costs associated with the existing dairy products line are $2,550,000 per year whereas such costs will reduce to $2,325,000 per year for the new cleaning products line. In addition to initial employee training cost of $60,000, there will be additional training expense of $40,000 in the first year. It is also estimated that the expanded operations of new product line will require an initial increased investment of $87,000 in stock and $63,000 in debtors that are offset by an increase in creditors of $55,000.
ALLPURE is going to fill-in a small portion of the total market demand and planning to maintain steady sales over the life of the project. Estimated annual sales revenue of cleaning products line will be $7,875,000; whereas, discontinuing dairy products line has annual sales of $7,500,000. Therefore, ALLPURE has to forgo annual before tax net profit of $4.848 million if the existing product line is replaced.
In accepting this project, the firm is planning to increase its debt-equity ratio by borrowing additional $500,000 at 10% interest. ALLPURE has a 12% weighted average cost of capital and is subject to a 30% tax rate. The required payback period is 3 years.
The CFO is hesitant about the decision because of replacing an entire product line. The CFO also asks whether or not the discount rate should be increased to allow for the risk of the above replacement or is the WACC appropriate?
Using Excel Spreadsheet prepare a full analysis to be presented to the CFO of ALLPURE Corporation evaluating whether the existing product line should be replaced by the new product line.
FIN20014_OUA: Individual Assignment Study Period-4, 2014
3 | P a g e
Your analysis should include, inter alia, the following • Table of cash flows as organised in excel spreadsheet; • Use of excel formulae where appropriate; • A written report (1200 words, +/- 10%) outlining your recommendation as to whether ALLPURE Corporation should proceed. Justify your recommendation and your analysis of risk.
Marks will be awarded for: • Set out of spreadsheet i. Ease of reading spreadsheet ii. Use of excel formulae in organised spreadsheet iii. Correct application of theoretical model • Overall presentation of answer including the written report.
* Carefully read the following Marking Rubric for required components and presentation of formal report.