Question

Trump De Drum Ltd (TDT) is a company in aquacultural industry specialised in farming of aquatic organisms. DT is considering opening a new farm in Sandy Bay. This project would involve the purchase of 13 hectares land at a price of $1,000,000 (Note that: The land is not subject to depreciation for accounting and tax purposes). In addition to that, the company will need to purchase eight special equiments which cost $125,000 each. The equipments are expected to be in use for 5 years and after that, they will be scrapped without any residual value. Each year, each of these equipments will incur $5,000 maintenance cost. It is assumed that the farm will first be used at the beginning of the next financial year: 1 July 2021.

Before starting this new operation, TDT will need to redevelop and renovate the warehouse at the farm. This is expected to cost $200,000. Assume that TDT is not able to claim any annual tax deduction for the capital expenditure to the renovation of the building until the business is sold.

Revenue projections from the farm for the next five years are as follows:

	Year 1	Year 2	Year 3	Year 4	Year 5
Beginning	1/7/2021	1/7/2022	1/7/2023	1/7/2024	1/7/2025
Ending	30/6/2022	30/6/2023	30/6/2024	30/6/2025	30/6/2026
Production quantity (tons)	120	140	170	185	185
Price (per tons)	$9,000	$9,150	$9,250	$9,300	$9,350

Operating variable costs associated with the new business including material costs and labour costs. Estimated material costs per tons in year 1 is $2,000 and this cost will increase by 3.5% every year. The farm will require about 6 workers working for 8 hours a day, 200 days per year. The pay rate is flat at $20/ hour including superannuation. Annual operating fixed costs associated with production (excluding depreciation) are $100,000. Existing administrative costs are $550,000 per annum. As a result of the new operation, these administrative costs will increase by 30%. The company is subject to a tax rate of 30% on its profits.

Meanwhile, TDT Ltd is currently financed by 60% of equity and 40% of debt. Company’s bond is traded at a price of $980. The bond has 10 year term, 8% coupon rate paid semi-annually and face value of $1,000. In addition, company’s equity has a beta of 1.2 while the risk-free rate in the market is 3% and market portfolio return is estimated to be 12%.

P. De Potato, the company CFO would like you to help him examine the viability of the project for the next five years, taking into account the projections of sales and operations costs prepared by company’s accountants.

Your tasks: Only Question 2 n 3 n 6 thanks.
the answer to other questions can find at
https://che.gg/2zaC2xe
https://che.gg/2VnCbGk

Based on the information in the case study, P. De Potato has asked you to write a report to TDT’s management advising them as to the best course of action regarding this project. Your report should address the following specific questions asked by management:

1. Calculate the Net present value (NPV) of the project, assuming that the initial investment could be sold at the end of the five years for $1 million. Briefly comment on your results and make appropriate remarks on the assumptions made for these calculations if necessary.
2. Estimate the Internal rate of return (IRR) of the project. Briefly comment on your results
3. Using sensitivity analysis, recalculate NPV using the scenario of
   1. A decrease in project sales by 10% annually.
   2. An increase of the sale price by 5% annually
   3. An increase of material costs change from 3.5% to 8% Briefly comment on your results.
4. In view of your answer to Point 4 to point 7 above, advise TDT’s management as to whether they should go ahead with the investment project. In your recommendations, you may wish to suggest possible refinements in the method used for evaluating this project.

Answer 1

ANSWERS TO QUESTION 2,3 & 6

• IRR is the internal rate of return. More precisely saying, it is the rate at which the NPV/ net present value becomes zero.The following table shows IRR calculations;

This IRR values gives us a green signal, to go ahead with this project.

• CALCULATION OF NPV WHEN

(a) A decrease in project sales by 10% annually.

(b) An increase of the sale price by 5% annually

• NPV is the golden rule to find out if a project is investment worthy or not and IRR is closely related to NPV. Since NPV is positive and IRR is more than satisfactory, the investment is worth pursuing. NPV & IRR are considered to be the best way to analysis the worthiness of a proposed project till date.