SONICJET Company produces small powerboats and faces the challenge to build and market environment-friendly green powerboat. Dr Pascal Goulpie, the director of PlanetSolar, stated that building an environment-friendly boat is possible for sure, but the market and demand are still niche right now. Many experts believe that resin-infusion technology will lead the industry for cleaner powerboats in future; however, that will take long time. However, SONICJET is not relying on that new technology to build greener powerboats. Rather, the company is now evaluating a new project to produce V-powerboats that will leave excessive carbon footprint in the water.
SONICJET invested $400,000 in the last year for designing its V-powerboat. Additional $150,000 was incurred to promote the boat to a number of distributors. However, considering a few major changes in the previous estimates, the Chief Financial Officer (CFO) of SONICJET Company has instructed to re-evaluate the project. The following further revised estimates are provided relating to this V-powerboat project.
The company requires additional plant for building the V-powerboat and the plant can be procured from a local importer at a cost of $12,000,000. Additional transportation and installation cost would be $40,000 and $160,000 respectively. The plant would have economic life of five years and will be depreciated using straight line rate of 15 per cent for tax purposes. At the end of the project life of five years, the plant is estimated to be sold for $4,500,000.
In addition to the plant, the project will require an initial investment in stock (inventory) of $200,000. Furthermore, projected tied up amount with debtors (accounts receivable) would be $190,000 and it would be partially offset by $40,000 increase in creditors (accounts payable). There will be no further investment in net working capital (NWC) until its final recovery at the end of project life. There will be initial market penetration expenses of $100,000 at the beginning of the project.
Considering positive responses received during promotional programs, and the economy price of $30,000 per boat only, sales manager of SONICJET is very optimistic to sell 400 V-powerboats in the first year. Due to competition and water pollution issues, annual sales will decrease by 30 boats every year during remaining life of the project. Within the range of producing 200 to 400 boats per year, variable cost of production is estimated to be 40% of sales revenue. The company will produce boats equal to the number of sales units estimated in a year. As per allocation from Head office of the company, this production plant requires to pay $120,000 per year for fixed factory overhead.
SONICJET company is planning to finance this project by issuing 10% debenture of $5 million and the remaining required investment would be financed by equity. Starting the V-powerboat project will stop other monthly earnings of $5,000 from the production facility of the SONICJET Company. Selling V-Powerboat will also increase monthly sales of powerboat parts for $20,000. Cost of production for these parts would be 40 per cent of sales revenue from parts.
The company uses required rate of return considering its weighted average cost of capital (WACC) that varies from 15 to 20 per cent in recent time. Management has decided to use 20 per cent required rate to evaluate this project. Corporate tax rate is 30%. The required discounted payback period is 4.5 years.
A new environment protection group, Clean-Our-Waterways, is trying to negotiate with the management of SONICJET Company to stop the V-Powerboat project due to its excessive carbon emission. In this context, company managers have identified another T-Powerboat project that would be relatively more environment friendly. Initial total investment for this T-Powerboat project would be the same as V-Powerboat project and projected future cash flows (after all adjustments) for this six-year project would be as follows:
Year-1: $3,600,000; Year-2: $4,200,000; Year-3: $4,600,000;
Year-4: $5,000,000; Year-5: $5,600,000; Year-6: $6,100,000;
Before taking final decision in the upcoming meeting, the CFO of SONICJET Company requires a clear explanation of all relevant issues relating to the V-Powerboat project. Particularly a FORMAL REPORT is enquired by the CFO to include a detail analysis of cash flows and explanations of results of capital budgeting methods that are commonly used in evaluating projects.
Furthermore, in a separate section in the report, CFO is interested to review the details of the comparison between V-Powerboat and T-Powerboat projects with respect to the results of capital budgeting methods using both 15 and 20 per cent required rates, crossover rate and all relevant factors that can assist in taking final decision.
Using Excel Spreadsheet, prepare a full analysis to be presented to the CFO of SONICJET Company in evaluating whether either project should be started or not. Your analysis should include the following
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