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Multi-chem Case Study - Management Assignment Help
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Assignment Task
Task 1: Multi-chem
You are a financial analyst in the capital projects department of Multi-chem, a specialty chemicals producer of fire-control chemicals, additives, and pesticides based in Queensland. Currently, Multi-chem 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. While Multi-chem has a large and expanding capital budget, it is currently considering which of two possible projects it should invest in, both of which would 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 Manila Plant, is a proposed new plant in the Philippines, about 30 km outside the capital. Multi-chem has been considering this expansion for a number of 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, in 2020 the Manila Plant will require the purchase of land for $2.55 million, with development and construction building costs of $13 million, and plant and equipment of $6 million. Multi-chem will also need to spend on working capital each year. The change in net working capital is estimated to be 4% of sales every year during the life of the project (the exception being the last year of the project which reverses the sum of all previous cashflows due to working capital). Sales are estimated to be $48.6 million in 2021, the first year of production, increasing by 10% per annum after that. The cost of goods sold is 65% of sales. Fixed costs will be $11.5 million in 2021, increasing by 5% 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 20% of cost and the plant and equipment will have no salvage value. At the end of the project, Multi-chem will rehabilitate the site and sell the land for light industrial development for $18.1 million. The company tax rate in the Philippines is 25%.
The second project, the Townsville Plant, is a modification of an existing plant Multi-chem already owns in the city of the same name in north Queensland. The Townsville Plant has been idle for a number of years, but with renovation would be well suited to furfural production. If not used for the proposed project, Multi-chem will lease out the existing plant for $70,000 per year. The estimated development and construction building costs will be $15 million in 2020 alongside plant and equipment investment of $5 million. Multi-chem will again need to invest in working capital, thus the change in net working capital is estimated as 4% of sales every year (the exception being the last year of the project which reverses the sum of all previous cashflows due to working capital). Sales will be $45 million in 2021, increasing by 7% per annum thereafter. Given 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 75% of sales. Fixed costs will be $5 million in 2021, increasing by 5% 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 30% of cost and the plant and equipment will have no salvage value. At the end of the project, the Townsville 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 Multi-chem’s CFO, Ms. Mary Miller, recommending which of these two mutually exclusive projects Multi-chem should invest in, if any. Your recommendation should be supported by appropriate calculations. Assume Multi-chem has a cost of capital of 12% for domestic projects and 16% for international projects.
Task 2 - Tomewin Water Company
Role and Context
You are a newly-hired financial analyst with Tomewin Water Company (TWC), a company operating in most states of Australia, which specializes in bottling purified water sourced from Tweed Valley springs. TWC 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
TWC currently has 30,000,000 ordinary shares outstanding that trade at a price of $41 per share. TWC also has 500,000 bonds outstanding that currently trade at $923.38 each. The company’s bonds have 20 year to maturity, a $1,000 par value, and a 8% coupon rate that pays interest semi-annually. TWC has no preferred equity outstanding and has an equity beta of 1.30. The risk-free rate is 1.5% and the market is expected to return 11.5%. TWC has a tax rate of 30%.
The initial outlay for the new project is expected to be $3,000,000, 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 1,250,000 units per year for $2.15 per unit. Variable costs are estimated to be $0.54 per unit and fixed costs are estimated at $50,000 per year. The above estimations are valid for 3 years of project life after which a terminal value of $500,000 in year 3 is expected to cover all cash flows to be earned in the future. For this project, working capital effects are ignored.
TWC’s CEO, Dr. Bob Green, has asked the finance department if they consider such project to be an acceptable investment. The CFO, Mrs. Sally Johnson, intends to evaluate the project based on the net present value approach. She agrees with Dr. Green on the major assumptions that will affect these cash flows, but they disagree on the appropriate discount rate. Dr. Green 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. Johnson obtains some data for several comparable companies as follows:
|
Company |
Cost of Equity |
Cost of Debt |
D/E |
Tax Rate |
|
Fruity Water |
21.0% |
8% |
0.43 |
34% |
|
Ladybug Drinks |
19.70% |
7.75% |
0.35 |
36% |
Task
- The CEO and CFO have asked you to provide a recommendation on 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:
- Worst Case: selling 1,000,000 units at a price of $1.85 and variable cost of $0.63 per unit;
- Best Case: selling 1,550,000 units at a price of $2.25 and variable costs of $0.49 per unit.
- Based on the above analysis, provide a recommendation on whether TWC should invest in this project.
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