Financial Decision Making-5

2

Case Study: Investment Appraisal for Tech Innovations Ltd.

Introduction

This assessment evaluates the learning outcomes of this module. Upon successful completion, students will be able to:

· Demonstrate an understanding and use of the appropriate analytical techniques for business case development, investment appraisal, raising finance, and distribution of funds to investors.

· Communicate financial information, analysis, issues, and recommendations clearly and concisely.

Background Information

Tech Innovations Ltd (a fictional company) is a UK-incorporated and UK tax resident technology company specializing in manufacturing and retailing internet-enabled home devices. The company has been conducting Research and Development (R&D) on a new smart thermostat and now needs to decide whether to launch the product and determine an appropriate price.

As the Business Manager responsible for the product launch, the CEO has tasked you with preparing a report on the investment in the new product. With the Finance Manager on leave for the next three weeks, the responsibility lies solely with you.

You have received the following information from various departments within the organization:

R&D Team

“We’ve spent quite a lot on developing this project - £520,000 – and it would be a shame if we didn’t bring it to market. We estimate that we need to spend another £80,000 on research costs to get it ready for launch.”

Production Department

“I’ve analyzed the production of the smart thermostat. We will need to purchase a new machine for large-scale manufacturing, costing £1,800,000. Our current staff has spare capacity to run the machine, but we will need to hire a ‘Specialist Supervisor’ for the machine. The HR team estimates the salary for this position to be £40,000 per year with a 3% annual inflationary increase. The machine will have a useful life of five years, and we should sell it for spares at about £420,000.”

Marketing Director

“I’ve researched potential pricing and customer targets, collaborating with the finance team to determine a wholesale price of £280 per thermostat over five years. The raw materials cost 30% of the sales price. We estimate the following sales for the first five years:

· Year 1: 20,000 thermostats

· Year 2: 22,000 thermostats

· Year 3: 28,000 thermostats

· Year 4: 34,000 thermostats

· Year 5: 18,000 thermostats

After five years, the technology will likely be outdated. The initial advertising and marketing campaign will cost £400,000 in year one, £600,000 in year two, and £200,000 in years three to five. HR confirmed the Supervisor’s salary and benefits start at £40,000 in year one, increasing by 3% annually.”

Financial Information for WACC Calculation

You have investigated the appropriate cost of capital (WACC) and gathered the following information:

· The market value of the shares is £3.00 per share, with 6 million ordinary shares issued. Dividends are expected to remain at 35p per share indefinitely.

· The company has £12m in irredeemable loan capital with an interest rate of 8%, currently quoted at £90 per £100. The effective tax rate is 20%.

The company has been using an estimated WACC of 18%, and the management team would like to see your calculations using this WACC. In the absence of the Finance Manager, the CEO wants you to present to the Board whether the project should proceed. The Board is interested in the techniques used to appraise investments, so provide a comprehensive explanation of your conclusion, including:

Rubrics

1. Executive Summary

2. Projected Cash Flow for the Project Over Its 5-Year Life

3. Explanation of Cost of Capital

· What is the Weighted Average Cost of Capital (WACC)?

· What is WACC used for?

· Your calculations of the WACC for the business show each component.

4. Financial Evaluation of the Project Using NPV and Payback Period Methods

· Calculations of NPV and Payback period using the WACC (detailed in the Appendix and calculated in Excel)

· Calculations of NPV and Payback period using the previous business cost of capital of 18% (detailed in the Appendix and calculated in Excel)

· A decision on whether the project should proceed, with justification.

5. Explanation of the Benefits and Limitations of the Four Main Investment Appraisal Techniques

6. Explanation of the Different Types of Funding Available to a Company

· Long-term, short-term, equity, debt, and others.

· Advantages and disadvantages of each.

· A detailed explanation of what a bank might consider when deciding whether to make a loan to a company and the steps they might take for extra protection on the loan repayment.

7. Conclusion

8. Reference List of at least 10 scholarly articles in Havard Referencing style.