Investment Proposal Evaluation for Hatfield Manufacturing Systems plc

Hatfield Manufacturing Systems plc (t0 = 2019)

Hatfield Manufacturing Systems plc (HMS plc) is an engineering firm which specialises in the design, development and manufacture of additive layer manufacturing systems (3D printing). Not only do HMS produce and sell 3D print machines to other engineering firms, but recently they have been supplying components to the aerospace and motor vehicle industries on a R&D trial basis. The trial has been so successful in terms of bothcomponent durability and production cost that HMS are evaluating a proposal to invest in a new plant dedicated to the manufacture of these components to be located in Turkey.

Turkey has a number of advantages in terms of plant location. The Turkish government is keen to attract inward investment and has been investing heavily to improve infrastructure. Turkey has an increasingly competitive automotive industry which achieved record output of 1.75 million vehicles in 2017 and a substantial and developing aerospace sector. Thus there is a high level of local engineering skills. 
 
Turkey also has a large and growing young population which is well educated. The unemployment rate in Turkey is currently 9.7%. However, the non-agriculture rate is 11.4% and amongst young people the rate is 16.9%. The HMS Board view is that this should give scope to recruit, train and retain staff without wage costs getting out of control. The Turkish economy is experiencing good growth with GDP growing by 7.3% in 2017 led by government investment in infrastructure and is on track for 5.5% growth in 2018.

There are, though, some challenges. The country is still dealing with fallout from the recent coup and negotiations with the EU have stalled. More recently a trade spat with the USA has created some instability particularly for the currency which is now trading at TL8.8257/£. Exchange rate and inflation data relating to Turkey and the UK.

The new plant will cost TL110m of which TL15m will be the cost of 3D print machines. It is company policy to depreciate the full cost of machines over 10 years. It is proposed that net surplus cash flows from the plant will be repatriated to HMS each year as a 
dividend. (Note - there is no double taxation of profits). Sales in the first year of operation (2020) are forecast to be TL15,518k and are expected to grow at 12% per year thereafter. Variable production cost will be TL1,467k in 2020 of which 35% will be labour cost. Labour costs are forecast to increase by 2% per year and other variable costs by 1.5% per year. The project also has fixed costs of TL1,144 which will increase at 1% per year.

The beta of HMS plc is believed to be 1.60. The normal corporation tax rate in Turkey is 22.0% but the Turkish government is keen to encourage DFI and applies a lower rate of 10% for initial DFI projects. The UK corporate tax rate is currently 19%. Both Turkish and UK corporate taxes are payable at the end of the year in question (you may assume for the purpose of this case that accounting profit and taxable profit are identical). All of the increased production from the Turkish plant will be exported in approximately equal proportions to South Korea, Canada and the EU. Thus the firm will have cash flows denominated in Won, and Ca. The sales revenues given above are the TL equivalent of these cash flows at current exchange rates. HMS plc ordinary shares are trading on the London Stock Exchange at £3.26 whilst their loan stock is trading at £101.63. During the last year the firm earned profit after tax of £13,470,000.

The HMS Board have a number of concerns and questions relating to the project. Is the project financially viable? Should they adopt a foreign or home country perspective? Will the project add value to HMS plc? How will exchange rate volatility impact on the value created for HMS? How should the project be financed?

Required:
Evaluate the investment proposal on behalf of Hatfield Manufacturing Systems plc and advise the firm whether the project is acceptable on a financial basis. Also, comment on the potential impact of foreign exchange risk on the project. You should support your arguments with relevant theory and calculations.

Your answer must be presented in the form of a report of 2000 words total. You must also submit an Excel spreadsheet containing your calculations and an appropriate formula linked evaluation model.