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18-01-2018

EQUINE INDUSTRIES

Equine Industries is considering a proposal to manufacture a high-protein horse feed. The project would make use of an existing warehouse, which is currently rented out to a local company. The annual rent received on the warehouse last year was $100,000. The new product line will also require an investment in plant and equipment of $800,000. Additional costs of $50,000 will be incurred for transportation and $30,000 for installation.

The new plant and equipment will be depreciated for tax purposes using the straight-line method over 10 years. However, Equine Industries expects to terminate the project after 5 years and resell the plant and equipment in year 5 for $300,000. The project also requires an investment in working capital of $250,000. Working capital will revert back to its initial level at the end of five years.

To ascertain the viability of this new product line Equine Industries has recently spent $35,000 conducting a market survey. As a result of the favourable outcome of this survey it has been decided by management to analyse this project further, using capital budgeting techniques. In addition to initial staff training costs of $45,000, there will be an additional training expense in the first year of $30,000.

Year 1 sales of the horse feed are expected to be $1.3 million (100,000 units at $13), with sales then forecast to grow by 10% a year. Manufacturing costs are expected to be 70% of sales. The new high-protein horse feed is anticipated to reduce the sales of an existing horse feed currently produced by Equine Industries. The expected reduction in sales of the existing product line is $200,000 per annum with a commensurate reduction in manufacturing costs of $150,000.

The firm has a 12% weighted average cost of capital and is subject to a 30% tax rate. The required payback is 3 years.

The Chief Financial Officer (CFO) is hesitant about introducing the new product line due to the high capital outlay required.

Objective:

The objective of this assignment is for students to solve a capital budgeting problem using an Excel spreadsheet and to present their analysis and recommendations in a formal business report.

Required:

In pairs, use Excel to prepare an analysis to be presented to the CFO of Equine Industries evaluating the proposed project.

The excel analysis should clearly identify group members and include the following:

  • Proforma income statement
  • Table of projected cash flows
  • Application of capital budgeting techniques to analyse the viability of the project (NPV, PI, IRR & Payback Period)
  • Sensitivity Analysis based on changes in quantity sold and price.
  • Use of Excel formulae where appropriate
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The pro forma income statement represents a trending statement that includes the probable net income value for the company considering the current growth and decline rates valid throughout the period of five years The cash flow statement is the determination of the cash that is present as a surplus or a slack with the business. The method of capital budgeting is the measure of the data through the discounted analysis of the models.

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