Evaluation of Investment Proposal for Herts Gadgets Intl plc and Management of Foreign Exchange Risk

Learning Outcomes: 

Knowledge and Understanding tested in this assignment:

1. evaluate strategies available to an organisation to enable the creation and maintenance of value;
2. assess the financing choices available to organisations and the relevance of capital structure;
3. analyse the financial and operating risks faced by organizations and the strategies for mitigating these risks;
4. research the specific issues relating investing and raising finance on an international basis

 Skills and Attributes tested in this assignment:

5. analyse financial statements and interpret the results in the context of value creation;
6. critically evaluate capital investment proposals both domestic and international including estimation of component and overall capital costs;
7. devise strategies for identifying and managing foreign exchange risk and the risks of international investment;
8. devise financial strategies f or enhancing enterprise value. 

Herts Gadgets International plc (t0 = 2021)

Herts Gadgets International plc manufactures and sells a range of machine tool accessories. The company is considering an investment of £13.0 million in new production plant and machinery for the product. The new facility is to be operational from 1 January 2022. It will have a life of five years and at the end of its life it will have a residual value of £1.0 million. It
is expected that the facility will have significant benefits.

Firstly, it will increase Herts Gadgets’ production output of diamond milling tools by 10%. Total contribution from new sales is expected to be £2,865,000 in 2022 increasing annually by 5% per annum until 2026. All the increased production will be exported in approximately equal proportions to South Korea, Spain and Canada. Thus, the firm will have cash flows denominated in Won, €, and $Ca and the contribution figure given above is the sterling equivalent of these cash flows at current exchange rates.

Secondly, it will reduce the product’s direct labour and direct material costs by 20% per unit which will result in savings of £1,680,000 on existing production in 2022. Having made these cost savings, the company expect costs to remain constant to 2026 due to continual efficiency improvements. The project also requires additional working capital of £2.0 million. Herts Gadgets pays corporation tax at the rate of 20% on its taxable profits which is paid one year in arrears. (Assume that net cash flow is the same as taxable profit).
A recent report by financial consultants suggests that the Herts Gadgets plc’s equity has a beta of 1.60 and reported that medium term UK government bonds are earning 2.89% per annum. In addition, the report noted that the FTSE All-share index increased by an average of 11.6% compound in each of the last three years.

Knowledge and Understanding tested in this assignment

Herts Gadgets plc ordinary shares are trading on the stock exchange at £1.65 whilst their loan stock is trading at £104.70. During the last year the firm reported an operating profit of £969,000.
Inspection of the Herts Gadgets plc balance sheet reveals the following: 

Long-term Liabilities: £000
7% Loan Stock 2023 500
Shares & reserves:
Ordinary shares par value  £1 1200
Profit and loss account  942
Shareholders funds 2642 

Required:

Evaluate the investment proposal on behalf of Herts Gadgets Intl 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. Also discuss and recommend the alternative sources of financing the project. You should support your arguments with relevant theory and calculations and indicate any non-financial matters you feel should be taken into consideration.

Your answer should be presented in the form of a report of 2500 words total (excluding the reference list). You must also submit an Excel spreadsheet containing your calculations.

Task 

Communication Skills (Written) – 20 Marks:

Marks will be awarded for

a) for the physical presentation and layout of your report,

b) adopting logical well supported (ie using appropriate citations) arguments,

c) the extent to which the report is accurate, brief, concise and clear,

d) the standard of English, and,
e) compliance with standard Harvard referencing. Equal account will be taken of each element. 

Knowledge & Understanding – 20 Marks:

You should establish a clear business focussed conceptual basis for your report – ie you need to show what you are seeking to achieve and why it is important for managing the Herts Gadgets plc business (supported using appropriate citations).

Synthesis – 20 Marks:

From the case data given you should identify the nature of the decision(s) facing Herts Gadgets plc and identify appropriate theory to support the approach you adopt and give your reasoning. Ie which analytical tools are consistent with ‘business focussed conceptual basis’ referred to above? (supported using appropriate citations).

Analysis – 20 Marks:

Using the case data given, you should apply the analytical methods identified in the previous section and evaluate the impact on the business in relation to the ‘business focussed conceptual basis’ referred to above.

Evaluation – 20 Marks:

Conclusions should be arrived at based on your analysis of Herts Gadgets plc issues; ie what do the results of your analysis tell you? In your conclusions section you should summarise the results of your analysis. Your recommendations will be assessed on the extent to which they are linked to the analysis of Herts Gadgets plc issues and on the extent to which they are theoretically coherent - ie the extent to which they are consistent with the theoretical/conceptual base you establish.