Course: Capital Budgeting: Case Study

Financial Management

Q1: On July 1, 2013, the Chief Financial Officer of ABC Foods Limited is considering a pro ect to produce toothpaste Tooth Care !hich re"uires #s $00,000 capital in%estment for ne! &"uipment for pac'aging( )he company has already spent #s *0,000 on #+, for the ne! product and it !as included as #+, e-pense in the first year .+L account, /ecause a ne! product had to pay for its #+, e-penses( )he e-isting product of the company is another tooth paste White Tooth( 0ince the same production machinery is used to produce the ne! toothpaste Tooth Care, no cost for production machinery has /een included in the ne! pro ect cost( )he /oo' %alue of the production machinery is no! #s 100,000 and it is e-pected to last for fi%e years more( 123rd of the e-isting production machinery !ill /e used for the production of ne! tooth paste Tooth Care. )he sales %olume of White Tooth has increased /y *03 o%er the last year( 0traight line method !ill /e used for depreciation of production and pac'aging machinery( 4hen !hite tooth needs the capacity, it !on5t /e a%aila/le( 4hite tooth !ill need the capacity in year 3, $ + *( )he estimate %olume foregone of 4hite )ooth !ill /e 3000 units in 6ear 3, *000 units in 6ear $ and 7,*00 units in year *( )he contri/ution margin foregone per unit !ill /e #s 12 in 6ear 3, #s 1* in 6ear $ and #s 18 in 6ear * and operating .rofit foregone per unit !ill #s 3 in 6ear 3 #s * in 6ear $ and #s 1 in 6ear *( 9t is e-pected that 7*3 of the sales %olume of ne! tooth paste Tooth Care !ill come from gro!th in the mar'et si:e of the population using the toothpaste and 2*3 !ould come from erosion of mar'et share of White Tooth( )he ;ad ustment5 item in the follo!ing ta/le represents erosion of White Tooth mar'et and !as calculated /y multiplying the %olume of erosion times a %aria/le profit contri/ution( )he financial year ends of June 30( )he corporate income ta- rate is 303( )he after<ta- !eighted a%erage cost of capital for Tooth Care pro ect is 1*3( )he life of the ne! pro ect is fi%e years( )he follo!ing is the forecast .+L Account for the ne! toothpaste Tooth Care for the fi%e years ending June 30, 6ear 0 6ear 1 6ear 2 6ear 3 6ear $ 6ear * =ross .rofits >/efore 200,000 2,*0,000 2,7*,000 2,*0,000 2,2*,000 su/tracting the depreciation of pac'aging machinery? ,epreciation of pac'aging 80,000 80,000 80,000 80,000 80,000 machinery ,epreciation on production $0,000 $0,000 $0,000 $0,000 $0,000 machinery >Tooth Care5s share? #+, &-pense *0,000 ;Ad ustment5 for erosion of 1*000 18,000 22,*00 2*,000 30,000 profits of White Tooth before tax @et 4or'ing Capital 2*,000 28,000 3*,000 20,000 1*,000 #e"uirement >Current Assets A @on<9nterest /earing Current Lia/ilities ? Required: i? ii? iii? &stimate the Free Cash Flo!s to the Firm of Tooth Care pro ect( Comment on the same also( &stimate the discounted pay/ac' period and @.B of Tooth Care pro ect( 0hould ABC Ltd launch Tooth Care?