FIN6011A - Applied Financial Management Assignment

Assignment Task

The objective of this assignment is for students to demonstrate their understanding of the principles and importantly, their applied skills in the process of Operational and Capital Budgeting. As the report is designed as a report to a company Board of Directors, a high standard of presentation is required.

The case involves the evaluation of investment options as described below. The recommended structure of the report is as follows:

• Introduction (background, aim and approach)
• Description and Rationale of Methods Used
• Capital Budgeting Evaluation using Payback Period and NPV:

Investment Option

A: Organised as a proprietary limited company, Bak Kwa Express (BKE) is a barbecued meat jerky business which commenced operations in Melbourne in 2012. The company enjoyed strong early success, which led to the establishment of ten retail outlets. In the last 3 years, however, BKE has felt the effect of competition from other Asian snack food outlets, resulting in annual sales of $720,000 per store not showing any growth.

The business is currently averaging gross margins of 56%. The gross margin is the ratio of: sales in dollars less cost of products sold sales in dollars.

BKE directors are currently considering a Revitalisation Strategy proposal to boost sales. It is expected that the strategy will result in an increase in sales with all stores: 6% growth each year for the first three years (Years 1, 2 and 3) and 3?ch year for the next three (Years 4, 5 and 6).

The first part of the Revitalisation Strategy is an ‘image overhaul’ which is to upgrade all stores to feature a new logo signage, and a modern looking façade. This would cost $300,000 per store. It is felt that the ‘image overhaul’ would suffice for six years without further capital investment during that time.

The second part of this Revitalisation Strategy is the introduction of premium raw materials and ingredients that will increase the products’ appeal. This would however cut the gross margin to just 53% if prices were to be maintained at their current levels, as is planned in the strategy.

More quality assurance and maintenance procedures are to be adopted. Thus, overall Administration and Overhead Expenses will increase by another $200 K from the current $2,800 K per year.

Increased Advertising and Promotion will also be undertaken, thus increasing these expenses by another $100 K from the current base of $360 K per year. The directors were not sure how to evaluate this project and decide on whether it should accept or reject it.

Then, there is the other potential unrelated investment opportunity of acquiring a groceries business as described in the following section. Interestingly, the investment requirement is also $3 million.

Investment Option

B: Andy Yeo, the owner of a large established grocery store business retailing imported and locally manufactured Asian products, has suffered from poor health recently and wishes to retire. As Andy has not found a suitable arrangement to continue running the business, he approached a BKE director who he is good friends with. Andy asked if BKE would be interested in acquiring his business. The grocery store called Yeo’s is in a suburb where there is no existing BKE outlet.

Andy Yeo revealed the following during a visit of BKE directors to his store:

• Yeo’s is being offered for sale for $3.0 million. The price includes All store equipment which has just been replaced last year and should be good for another 8 years. Existing merchandise inventory worth $600,000.
• There are no debts.
• Andy showed extracts of his Certified Practicing Accountant’s (CPA) reports that revealed an average sales turnover of $1,220,000 a month for the last twelve months.
• Andy feels that as the demand for his products has increased because of the influx of recent migrants in the suburb, sales could increase by 5% a year for the next 6 years.
• The store still has six years to go on the lease of the place. There is no certainty however that the lease can continue beyond 6 years; if BKE discontinued the business at that time, store equipment could be possibly sold for $100,000.
• Asked who will take over his tasks when he exits the business, Andy says a store manager would need to be hired with an annual remuneration of $120,000. It turned out that Andy as the sole proprietor was not being paid a regular salary for his work.
• As to profitability, the CPA’s reports indicate that the business points to a consistent Net Profit Percentage of Sales of 6.5% for the last three years.

Capital for Investment

Due to BKE’s track record and good relationship with their bank, BKE has been pre-approved to avail of a term loan of $2 million whichever Investment Option they decide on.

Above the loan amount, the balance of the investment required can be contributed by the company from their retained earnings with $1.5 million available.

The current capital structure of BKE comprises of 50?bt / 50% Equity. If this proportion would apply on the new capital required (i.e. $1.5 million new loan and $1.5 million BKE retained earnings), the BKE director for finance feels that their weighted average cost of capital (WACC) will remain at 10%.

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