Question

In order to take full advantage of the growing markets of mobile phones in the ASEAN, WingWei Corporation has decided to setup its first manufacturing unit in Malaysia. When officially launched in January 2020, WingWei expects to sell their phones only through their official retail stores. WingWei has estimated to invest RM 50 million in initial investment. This investment includes the market cost of land, basic machineries, and modification cost of the machines. To avoid long-term risk, WingWei has decided to sell the project to Malaysian government at the book value at the end of year 2022. To complete initial setup and to operate from the beginning of year 2020, WingWei has asked for an initial working capital investment of RM 10 million and the amount of working capital will increase by 5% p.a. to support the growth of sales. The fixed investment in the project (i.e. land, machineries and others) will be depreciated at 20% each year. WingWei has estimated the demand in local market to be 0.10 million units p.a. and the sale will grow at a rate of 10% p.a. for the next three years. Each unit will be sold at RM 1000. Price per unit will be kept fixed over time to win the competition. Variable costs are estimated to be 30%, 40% and 45% p.a. of the total sales over the next three years. Salaries, administrative and other overhead costs are estimated to be 5% p.a. of the total sales. The Company has estimated that the cost of debt after tax is 4% p.a. and cost of equity is 12% p.a., and these figures are assumed to be constant over the next three years. Assume that the Company has a debt-to-equity ratio of 0.4. The corporate tax rate for WingWei is 20% p.a.

(i) Estimate the free cash flows to firm during the operating life of the project. [30 marks]

(ii) Calculate the net present value and the internal rate of return of the project.

Answer 1

a. Free Cash Flows to Firm

Year 0 = RM -60,000,000

Year 1 = RM 58,700,000

Year 2 = RM 54,715,000

Year 3 = RM 86,265,000

b. NPV = RM 104,277,271

IRR = 87%

Note:

It is assumed that working capital invested will be recovered at the end of the project. In the absence of relevant information in question, it is a fair assumption to make as typically working capital gets recovered when the project is wound up.

Workings: