Financial Decision Making: Analysis of Three Scenarios

Upon the successful completion of this module, the student should be able to:

• Apply and critically evaluate the relevant theoretical framework and models of international financial management;
• Evaluate, apply and critically discuss various methods and techniques relating to the financing of an international business;
• Aapply and critically appraise various theoretical models of corporate value, international cost of capital, and financial structure.

1. The managing director of Curt plc is irritated that the supplier for the component widgets has recently increased prices by another 10 per cent following similar rises for each of the last five years. Based on the assumption that this pattern will continue, the cost of these widgets will be

The managing director is convinced that the expertise for the manufacture of widgets exists within Curt. He therefore proposes the purchase of the necessary machine tools and other items of equipment to produce widgets in-house, at a cost of £70,000. The net cash outflows associated with this course of action are:

Note: The figures include the £70,000 for equipment and operating costs, etc.

The machinery has a life of five years and can be sold for scrap at the end of its life for £10,000. This is not included in the £88,000 for year 5. The installation of the new machine will require the attention of the technical services manager during the first year. She will have to abandon other projects as a result, causing a loss of net income of £48,000 from those projects. This cost has not been included in the above figures.

The discount rate is 16 per cent, and all cash flows occur at year ends except the initial investment.

Help Curt plc to decide whether to produce widgets for itself. What other factors might influence this decision?

2. Clipper owns 100 acres of mature woodland and is trying to decide when to harvest the trees. If it harvests immediately the net cash flow, after paying the professional loggers, will be £10,000. If it waits a year the trees will grow so that, the net cash flow will be £12,000. In two years, £14,000 can be obtained. After three years have elapsed, the cash flow will be £15,500, and thereafter will increase in value by £1,000 per annum.

Calculate the best time to cut the trees given a cost of capital of 10 per cent.

3. Hose plc is trying to make a decision on whether to make a commitment of £800,000 now to a project with a life of seven years. At present prices, the project will return net cash flows of £150,000 per annum at the year ends. Prices are not expected to remain constant, and general inflation is anticipated at 6 per cent per annum. The annual net cash inflows of this project are expected to rise in accordance with general inflation. The money rate of return is 13 per cent. Advise Hose on the viability of this project.