Question

financial management

Sprint Bolt Ltd is a producer of specialised sport shoes. The company has been conducting research and development of a new model, where the lower mould can automatically adjust itself to avoid foot injury. The model has been tested and the managing board is happy to launch its production if it is financially viable.
The company has already spent $800,000 for research and development. The new model will have a five- year lifetime, after that the company will stop its production. The new production facilities and equipment will cost $22,000,000 which will be depreciated on a straight-line basis to zero book value. The company will not sell the equipment after the production of new product is finished.
The company expects to sell 80,000 pairs in the first year at $300 per pair. As the new technique can be potentially followed by competitors, every year the sale quantity is expected to decrease by 10% and the sale price will decrease by 8%. Variable costs are expected to be 40% of sales. While the new model generates a high gross profit rate, the company expects a high level of product returns of 5% on sales.
As a financial manager of the company, you’re conducting a capital budgeting analysis of the financial viability of the new model.
The company tax rate is 30%. Company’s required payback is 2 years and required rate of return is 25%. Assume that all cash flows are made at the end of each year.
Calculate the incremental cash flows for each year (Y0 to Y5 inclusive). (20 marks)
Calculate the payback period of the project. (4 marks)
Calculate the net present value, that is, the net benefit or net loss in present value terms of the project. (6 marks)
Calculate the present value index of the project. (3 marks)
Calculate the discounted payback period of the project. (6 marks)
Calculate the internal rate of return of the project. (8 marks)
Identify and explain what other factors Sprint Sport should consider. Explain if the company should accept the project or not. (5 marks)

Answer 1

Capital budgeting is a method used to determine the risk and return of undertaking a new project, so as the comapny may decide whether or not to undertake it.

There are various capital budgeting methods which include Net present value. IRR method and payback period method.

The incremental cash flow each year woud be as follows.

Year	Units (Reduce every year by 10%)	Rate per unit(reduce every year by 8%)	Sales	Sales Return (5% of sales)	Variable Cost (40% of sale)	Deprciation	Tax (30%)	Cash Flow	incremental cash flow
0
1	80,000	$300	=80,000 x 300= $24,000,000	$1,200,000	=24,000,000 x 40%= $9,600,000	=$22,000,000/5 =$4,400,000	=(24,000,000 - 1,200,000- 9,600,000- 4,400,000) x 30%= $2,640,000	=net profit + Dep = 10,560,000	10,560,000
x 2	72000	$276	=72000 x 276= $19,872,000	$993,600	$7,948,800	$4,400,000	=$1,958,880	=8,970,720	=19530,720
3	64800	$254	=64800 x 254= $16,459,200	$822,960	$6,583,680	$4,400,000	=$1,422,768	=7,629,792	=27,160,512
4	58320	$234	=58320 x 234= $13,646,880	$682,344	$5,458,752	$4,400,000	=$931,736	=6,574,048	=33,734,560
5	52488	$215	=52488 x 215= $11,284,920	$564,246	$4,513,968	$4,400,000	=$542,012	=5,664,694	=39,399,254

Payback period

Year	0	1	2	3	4	5
Inital Cost	8,000,000
Cost of equipment	22,000,000
Cash inflows	-	10,560,000	8,970,720	7,629,792	6,574,048	5,664,694
Payback

Payback= 3yrs + (6,574,048/365) x 3734560

=3yrs + 208 days