Prepare a business-style response to a hypothetical but realistic situation. Each performance task includes information detailing your role, a scenario, and a task to which you are required to respond.
You will use the information presented in each case in carrying out the task. While your personal
values and experiences are important, you should base your response on the evidence provided in
these tasks along with your knowledge gained in the course. It is important that you provide clear
evidence of your ability to apply your knowledge of finance as learned in the course to the task.
Submit your response in an Excel file which should contain four (4) worksheets named as: Task 1,
Report 1, Task 2, and Report 2. The Task worksheets should contain the calculations and workings,
while the Report worksheets should contain a brief one page report where you present the findings,
considerations, recommendations, conclusions or any other issues relevant to each task. For
presentation purposes in the Report worksheets, either type in cells directly and then remove
gridlines, or insert pdf or word pages as pictures.
By submitting this take-home examination for assessment, students acknowledge Sect. 6.1
Assessment Related Policies and Guidelines, University Policies & Guidelines in the Course Profile in
relation to academic misconduct.
2 | Page
Task #1: Griffin
Role and Context
You are a financial analyst in the capital projects department of Griffin, a speciality chemicals producer of
fire-control chemicals, additives, and pesticides based in Queensland. Currently, Griffin is small in scale but
embarking on a rapid expansion and modernization program. It is also expanding its range of products into
dyes, rubber compounds, and water treatment chemicals. Along with the projects considered here, Griffin
is also currently undertaking evaluation of projects expanding its existing facilities in SE Queensland, the
acquisition of another chemical producer in Victoria, a joint venture with a US company producing fuel
additives, and various production and warehouse upgrades in a few smaller plants in NSW and South
Australia. While Griffin has a large and expanding capital budget, it is currently considering which of two
possible projects it should invest in, both of which will be used to manufacture furfural (an organic
compound derived from agricultural by-products) and furfural-based derivatives to make resins, urethanes,
and refining solvents over a 10-year operating period.
Scenario
The first project, the Djakarta Plant, is a proposed new plant in Indonesia, about 40 km outside the capital.
Griffin has been considering this expansion for many years and believes that the combination of low wages,
looser environmental protection, and proximity to its emerging markets in SE Asia will makes this new plant
an attractive addition to its existing facilities. Specifically, now, in 2019 the Djakarta Plant will require the
purchase of land for $3.55 million, with development and construction building costs of $19 million, and
plant and equipment of $4 million. Griffin will also need to spend on working capital each year. The change
in net working capital is an increase of $50,000 plus 3% of sales every production year during the life of the
project (the exception being the return of all the previous working capital in the last year of the project).
Sales are estimated to be $45.6 million in 2020, the first year of production, increasing by 11% per annum
after that. The cost of goods sold is 60% of sales. Fixed costs will be $12 million in 2020, increasing by 4%
per year. Both buildings and plant/equipment will be depreciated straight line to zero over the 10-year
project life. The buildings will have a salvage value of 25% of cost and the plant and equipment will have
no salvage value. At the end of the project, Griffin will rehabilitate the site at a cost of $7 million and sell
the land for light industrial development for $15.6 million. The company tax rate in Indonesia is normally
20%, but the new government is offering an incentive for the first three years of operation for major
manufacturing projects where the tax rate will only be 18%, before reverting to the normal rate.
The second project, the Gladstone Plant, is a modification of an existing plant Griffin already owns in the
city of the same name in north Queensland. The Gladstone Plant has been idle for several years, but with
renovation would be well suited to furfural production. If not used for the proposed project, Griffin will
lease out the existing plant for $90,000 (before tax) per year. The estimated development and construction
building costs will be $17 million this year alongside plant and equipment investment of $6 million. Griffin
will again need to invest in working capital, thus the change in net working capital will be an increase of
$40,000 plus 4% of sales every year when production commences in 2020 (the exception being the return
of all the previous working capital in the last year of the project). Sales will be $47 million in 2020, increasing
by 7% per annum thereafter. Based on the relative geographic isolation of the plant and the stricter
environmental controls given the proximity to the Great Barrier Reef, the cost of goods sold will be 70% of
sales. Fixed costs will be $5 million in 2020, increasing by 4% per year. Both buildings and plant/equipment
will again be depreciated straight line to zero over the 10-year project life. The buildings will have a salvage
value of 25% of cost and the plant and equipment will have no salvage value. At the end of the project, the
Gladstone Plant will again revert to being idle awaiting potential future developments at no cost. The
company tax rate in Australia is 30%.
Task
Provide a report to Griffin’s CFO, Ms. Kirsten Robertson, recommending in which of these two mutual
exclusive projects Griffin should invest, if any. Assume Griffin has a cost of capital of 11% for domestic
projects and 17% for international projects.
3 | Page
Task #2: Gold Coast Water Company
Role and Context
You are a newly hired financial analyst with Gold Coast Water Company (GCWC), a company operating in
Queensland, which specialises in bottling purified water sourced from Tambourine Mountains springs.
GCWC is considering adding to its product mix a ‘healthy’ bottled water geared towards children, aimed at
improving both its business focus and the return to shareholders.
Scenario
GCWC currently has 30,000,000 ordinary shares outstanding that trade at a price of $35 per share. GCWC
also has 400,000 bonds outstanding that currently trade at $983.38 each. The company’s bonds have 20
year to maturity, a $1,000 par value and a 10% coupon rate that pays interest semi-annually. GCWC has no
preferred equity outstanding and has an equity beta of 2.21. The risk-free rate is 2.5% and the market is
expected to return 10.52%. GCWC has a tax rate of 34%.
The initial outlay for the new project is expected to be $5,000,000, which will be depreciated over the next
3 years using the straight line method to a zero salvage value, and sales are expected to be 1,650,000 units
per year at a price of $2.05 per unit. Variable costs are estimated to be $0.62 per unit and fixed costs are
estimated at $75,000 per year. The above estimations are valid for 3 years of project life after which a
terminal value of $580,000 in year 3 is expected to cover all cash flows to be earned in the future. For the
purpose of this project, working capital effects are ignored.
GCWC’s CEO, Ben Waters, has asked the finance department if they consider such project to be an
acceptable investment. The CFO, Mrs. Alexandra Robinson, intends to evaluate the project based on the
net present value approach. She agrees with Mr. Waters on the major assumptions that will affect these
cash flows, but they disagree on the appropriate discount rate. Mr. Waters believes that they should use
the company’s weighted average cost of capital (WACC), however, the CFO disagrees, arguing that the
bottled water targeted at children has different risk characteristics from the company’s current products.
She argues that the company’s WACC is inappropriate as a discount rate and they should instead use the
‘pure play’ approach and estimate a cost of capital based on companies that sell similar type of products.
To do this, Mrs. Robinson obtains some data for several comparable companies as follows:
Company Cost of Equity Cost of Debt D/E Beta Tax Rate
Sunny Water 12.12% 7% 0.35 1.2 32%
Labrador Drinks 12.93% 7.55% 0.40 1.3 34%
Task
The CEO and CFO have decided to rely on your newfound expertise as to provide a recommendation on
why the company’s WACC should not be used, and if not, what is the appropriate discount rate to be used
in the appraisal of the new project. Concerned about the forecasting risk of this project, they also ask that
you perform a risk evaluation in the form of:
- Sensitivity analysis for sales price, variable costs, fixed costs and unit sales at ±10%, ±20%, and ±30% from
the base case, showing on a graph which variables are most sensitive; - Scenario analysis on the following two scenarios:
a) Worst Case: selling 1,250,000 units at a price of $1.75 and variable cost of $0.68 per unit;
b) Best Case: selling 1,750,000 units at a price of $2.25 and variable costs of $0.49 per unit.
Based on the above analysis provide a recommendation whether GCWC should invest in this project.