Question

Roll-on (Ltd), South Africa , is a specialist manufacturer of ‘roller door’. In seeking to expand its operations, it has the opportunity to acquire an American subsidiary company, Door Dynamics or set up a new division in South Africa. The relevant figures for these two options are as follows

Set up new division at home (RSA)      

Costs	Rands(millions)
Cost of premises	30. 400
Machinery	22. 000
Annual Sales	16. 000
Annual variable cost	5. 000
Additional head office expense	1. 000
Existing head office expenses	0. 500
Depreciation: machinery (10%)	2 .200

Acquisition (Door Dynamics)

Costs	Rands(millions)
Acquire shares from existing shareholders	10. 000
Redundancy cost	2. 500
Annual Sales	18.000
Annual variable cost	9.500
Annual fixed cost	5.500
Consultation fees	5.800

Additional information:

• Project life is 10 years
• Roll-on (Ltd) current cost of capital is 12%
• Inflation in the USA is expected to be below the South African inflation by 3% per year, throughout the life of the project.(Hint: use 9% as discount rate)
• Assume the current rate of R16 to 1 USD.

Required

1.1) Make all the necessary calculations for the 2 options.

1.2) Advise Roll-on (Ltd) on the viability of the 2 options.

You are required to use TVM calculations with cash flows and NPV

Answer 1

The option of starting new division would be beneficial since, the net present value is higher in that option when compared to aquiring the subsidiary.

Further in the question, under both the options, the currency is given as RANDS...so, no conversion is done in the calculations, into USD. In case the question is wrong, then the answer would change. However, the procedure would remain same as I answered below.

Net Present Value computation for setting up new division:

Company will incur premises cost and machinery cost of the initial stage itself, So, NPV factor is 1.

Particulars Yrs 1-10

Annual Sales 16000

Less: Annual variable cost (5000)

Less: Additional head office expenses (1000)

Less: Existing head office cost :

Less: Depreciation 10000

PV annual factor @ 9% for 10 years 6.42

Present value of annuity is (10000 x 6.42) 64200

Net Present value for the option:

Present value of annuity 64200

Less: Cost of premises (30400)

Less: Mchinery cost (22000)

Net Present Value of the option 11800

Net Present Value computation for acquiring subsidiary :

Shares acquisition cost and redundancy cost are to be incurred at the initial stage itself. So, NPV factor is 1.

Consultation fees also would be one time expense, incurred at the initial stge itself. So, NOV factor is 1..

Particulars Yrs 1-10

Annual Sales 18000

Less: Annual variable cost (9500)

Less: Annual fixed cost    (5500)

Annual incremental cash flow 3000

PV annual factor @ 9% for 10 years 6.42

Present value of annuity is (3000 x 6.42) 19260

Net Present value for the option:

Present value of annuity 19260

Less: Shares cost (10000)

Less: Redundance cost (2500)

Less: Consultation fees (5800)

Net Present Value of the option 960