Natural Amalgamated Chemicals - Smart Water Group Case Study - Accounting and Finance Assignment Help

Assignment Task :

Task 1: Natural Amalgamated Chemicals
Role and Context
You are a financial analyst in the capital projects department of Natural Amalgamated Chemicals (NAC), a specialty chemical producer of fire-control substances, additives, and pesticides based in Queensland. NAC is currently considering these two possible projects, 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. Currently, NAC is small in scale and cannot take both projects, however, the management is eager to embark on a rapid expansion and modernization program.
 

Scenario
The first project, the Ho Chi Minh Plant, is a proposed new plant in Vietnam, about 30 km outside the capital in the Long An province. NAC 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 Asia will make this new plant an attractive addition to its existing facilities. Specifically, now in 2020, the Ho Chi Minh Plant will require the purchase of land for $2.75 million. The costs for development and building construction are $13 million and for plant and equipment $6 million. NAC will also need to spend on working capital. To help you with the forecast, the project assistant has already determined the change in networking capital to be 3% of sales every year during the life of the project. Sales are estimated to be $48.6 million in 2021, the first year of production, then increasing by 10% per annum. The cost of goods sold is 65% of sales. Fixed costs are $11.5 million in 2021, increasing by 5% per year. The 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 the cost and the plant and equipment will have no salvage value. At the end of the project, NAC will rehabilitate the site and sell the land for light industrial development for $17.8 million. The company tax rate in Vietnam is 25%.
The second project, the Mackay Plant, is a modification of an existing plant NAC already owns in the city of the same name in north Queensland. The Mackay Plant has been idle for many years, but with renovation would be well suited to furfural production. If not used for the proposed project, NAC will lease out the existing plant for $60,000 after tax per year. The estimated development and construction costs are $15 million this year in 2020, alongside with the investment in plant and equipment of $5 million. NAC will again need to invest in working capital. The change in net working capital is 4% of sales every year. Sales will be $45 million in 2021, the first year of production, 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 is 75% of sales. Fixed costs are $5 million in 2021, increasing by 4% per year. The buildings and plant/equipment will again be depreciated straight-line to zero over the 10-year project life. The renovated buildings will have no salvage value and the plant and equipment have 20% salvage value. At the end of the project, the Mackay Plant will revert to being idle awaiting potential future developments at no cost. The company tax rate in Australia is 30%.

Task
Briefly outline the benefits/limitations of each project and recommend to NAC’s CFO, Ms. Alexandra Robinson, whether NAC should invest in these projects if any. Your recommendation should be supported by appropriate calculations. Assume NAC has a cost of capital of 12% for domestic projects and 15% for international projects.

Task 2: Smart Water Group
Role and Context
You are a newly hired financial analyst with Smart Water Group (SWG), a company operating in most states of Australia, which specialises in bottling purified water sourced from local water springs. SWG is considering adding to its product mix a ‘healthy’ bottled vitamin water geared towards children, aimed at improving both its business focus and the return to shareholders.
 

Scenario
In their last annual report, SWG showed 30,000,000 ordinary shares outstanding that had a trading price of $43 per share. SWG has just completed a 3 for 2 split to encourage more investment in its shares. SWG also has 550,000 bonds outstanding that currently trade at $935 each. The company’s bonds have a 20-
year life, a $1,000 par value and a 10% coupon rate that pays interest semi-annually. SWG has no preferred equity outstanding. The equity beta is 1.15. The risk-free rate is 1.5% and the market return is 11.5%. SWG has a tax rate of 34%.
The initial outlay for the new project is expected to be $2,500,000, which will be depreciated over 3 years using the straight-line method to a zero-salvage value, and sales are expected to be 1,250,000 units per year at a price of $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 project is expected to have an indefinite life, however, the company has estimated after-tax terminal cash flow in year 3 of $500,000. For the purpose of this project, working capital effects are ignored.
SWG’s CEO, Dr. Adam Richards, has asked the finance department if they consider such a project to be an acceptable investment. The CFO, Mrs. Kerry Davenport, intends to evaluate the project based on the net present value approach. She agrees with Dr. Richards on the major assumptions that will affect these cash
flows, but they disagree on the appropriate discount rate. Dr. Richards 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 types of riskier products. To do this, Mrs. Davenport obtains some data for several comparable companies as follows:

Task
1) The CEO and CFO have decided to rely on your newfound expertise as to provide a recommendation on the appropriate discount rate to be used in evaluation of the new project.
 

2) Concerned about the forecasting risk of this project, they also ask that you perform a risk evaluation on the base case NPV 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 of the following two scenarios:
a) Worst Case: selling 925,000 units at a price of $1.80 and a variable cost of $0.65 per unit;
b) Best Case: selling 1,550,000 units at a price of $2.25 and variable costs of $0.49 per unit.

3) Finally, advise the CEO and CFO whether this project is an acceptable investment taking into consideration the capital budgeting technique used and the risk analysis performed.

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