Capital Investment Analysis

Capital Investment Analysis

The a2 Milk Company is considering an expansion to their existing icecream production plant. Key points in regards to the new plant are as follows:

  • The initial cost of the expansion will be $20 million. The new plant will have a useful life of 10 years (assume straight line depreciation).
  • In the first year of operation, the new plant is expected to:
    • increase the firm’s revenues by $9.5 million. These revenues are expected to increase by 9% p.a. over the life of the plant. On average, cost of sales is 55% of sales revenue
    • increase the firm’s other costs by $400,000. These costs will increase by 4% p.a. over the life of the plant.
  • In year 1, the firm will engage a marketing firm to conduct research to better understand customer preferences towards a2 icecream. The cost of this study will be $100,000. This is a one off expenditure.
  • In year 6 of operation, the plant will require a one-off overhaul. This is expected to cost $200,000.
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  • The firm’s tax rate is 30%.
  • The firm requires a 9% required rate of return on all potential investments.

Required:

  1. In relation to the above proposal, calculate the:
    1. Annual after tax cash flows and annual after tax profit
    2. Payback period
    3. Net present value and internal rate of return
    4. Accounting rate of return (4 Marks)
  2. Provide an overview of the key environmental factors that the firm should consider in evaluating the proposal (3 Marks)
  3. Based on an assessment of financial considerations and other factors, provide a recommendation as to whether the firm should go ahead with the proposal. Illustrate and discuss how sensitive your recommendations are to changes in projections of the financial impact of the new capital investment. (3 Marks)

Ensure that your answers for the above are discussed and supported by relevant calculations/workings.

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