Capital Budgeting Analysis for V-GAMES Ltd's B_CONNECT Project

This assignment is a problem-solving exercise using an Excel spreadsheet with additional discussion on findings, forecast errors, and risk. Scenario Assume that you are an adviser at V-GAMES Ltd, which is analysing the introduction of a new game console called B_CONNECT. This system can be connected to human brain functions. It is still very much controversial for claimed but yet to be confirmed adverse impacts on human behaviour after prolonged application. Health-conscious groups are also lobbying against the introduction of such games with probable detrimental effects. The project manager of V-GAMES Ltd needs a detailed analysis of this exciting B_CONNECT project. She comes into your office, drops a consultant’s report on your desk, and complains, 'We paid these consultants $1 million for this report, and I am not sure their financial analysis makes sense, though their estimations seem to be correct. Before we spend $70 million on buying new equipment needed for this project, look it over and give me your opinion.' You open the report and find the following information and estimates: The project will continue for the next six years. By that time, more reliable information on possible adverse impacts of using B_CONNECT will be available. It is projected that the equipment will have an economic life of eight years. After buying the equipment, it requires a renovation of the production bay at V-GAMES Ltd and installation of the equipment at a total cost of $3.5 million. These renovation and installation costs are to be considered as capital expenditures. The market promotion expenses of $3 million is to be incurred initially at the start of the project. The equipment will be procured from Japan, and V-GAMES Ltd has to pay 11% import duty on purchase price, whereas the supplier will pay transportation costs of $60,000. The property, plant and equipment (PPE) would be depreciated over its useful life of eight years using a tax-allowable straight-line rate of 12%. However, the company is planning to sell the equipment at the end of the project for an estimated price of $9 million. Consultants estimate that 120,000 B_CONNECT consoles can be sold in the first year with an expected increase of 20% each year for the next two years. After that, sales are expected to decrease by 25% each year until the end of the project due to a number of factors including the actions by the competitors in the market. After careful analysis of the cost structure, it is finally decided to calculate variable operating costs at 43.8% of sales. As per analysis, the annual fixed operating cost, excluding depreciation, will be $2.3 million. Beginning selling price per console will be $600, which will be dropped by 10% in the fourth year for the rest of the project life. For the duration of the B_CONNECT project, V-GAMES Ltd is also estimating an additional monthly cost of $15,000 to be spent by the quality assurance officers. Existing facilities to be used for this project are coming from another production line that earns net $21,000 per month. That production line will be discontinued on the commencement of this B_CONNECT project. It is also estimated that the new production line will require an initial increase in investment for $930,000 in stock (inventories) and $710,000 in debtors (accounts receivable) that are offset by an increase in creditors of $370,000 (accounts payable). There will be no further investment in net working capital (NWC) until its final recovery at the end of the project's life. The company uses the required rate of return considering its weighted average cost of capital (WACC), which varies from 15% to 21% in recent time. The analyst is confused about the rate to be effective for the project; however, she has decided to use a 15% required rate to evaluate this project. The required discounted payback period is three years. Corporate tax rate is 30%. The project manager hesitates to make the final decision because of unexpected growth in the game industry with technological advancement in different directions. As an alternative, V-GAMES Ltd has an offer to introduce an upgraded version of a safe traditional game console—the P_CONNECT. Initial total investment for this P_CONNECT project would be the same as the B_CONNECT project, and projected net future cash flows (after all adjustments) would be as follows: Year 1: $45,600,000 Year 2: $39,900,000 Year 3: $36,700,000 Year 4: $20,400,000 Year 5: $13,800,000 Year 6: $12,600,000 Year 7: $2,700,000. Before making the final decision in the upcoming meeting, the project manager of V-GAMES Ltd requires a clear explanation of all relevant issues relating to the B_CONNECT project. Particularly, a FORMAL REPORT is required by the project manager to include a detailed 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, the project manager is interested to review a detailed comparison between the B_CONNECT and P_CONNECT projects with respect to the results of applicable capital budgeting methods using both 15% and 21% required rates, crossover rate, and all relevant factors that can assist in making the final decision. Your assignment will require the following: Using an Excel spreadsheet, prepare a full analysis to be presented to the project manager of V-GAMES Ltd to assist in evaluating whether either project should be started or not. Your analysis should include the following: A table of cash flows (show all digits, do not convert amounts to $ in million or thousand). Use of Excel formulae where appropriate. A written report (1500 words, +/- 10%) outlining your recommendation as to whether V-GAMES Ltd should proceed with either project. Justify your recommendations using quantitative and qualitative issues, and your analysis of probable risks and benefits relating to the project. A comparison statement is to be presented in a separate section in the report. Suggested format for the formal report: Executive summary Table of contents Body Introduction Findings Quantitative (with explanations of results) Qualitative Recommendations and justifications Detail comparison and further recommendations Conclusions References: List of all in-text references used in the report Appendix Workings Extracted copy of Excel spreadsheet. You will submit the following documents: The formal report. The Excel spreadsheet displaying values. The Excel spreadsheet displaying Excel formulae. ---------------------------------