The General Manager (GM) of RUNWELL Corporation needs a detail analysis on an exciting

proposal to introduce a new line of vehicle parts for environmental protection against carbon

emission. Starting the production line requires renovating one existing section of the factory. It

will be a B2B contract based project that will continue for eight years. It’s projected that

technological up-gradation of car manufacturing process will make this production line obsolete

in ten years’ time.

In winning this contract through a bidding process, the company has spent $41,000. Required

renovation can be conducted immediately at a cost of $130,000 that includes installation cost of

new plant and equipment (P&E). The contract requires annual quality assurance inspection that

will cost $36,000 per annum. The procurement of HR will be one-off cost at the beginning and

estimated to be $48,000.

FIN20014 Financial Management: Individual Assignment Sem-1, 2015

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A local distributor of a Japanese company can immediately supply all required parts and

accessories of the new P&E for a total charge of $1,400,000 including import duty of $210,000.

In addition, transportation cost of $40,000 and installation costs of $70,000 are to be incurred

for new P&E. These P&E would be depreciated over its useful life of ten years using a tax

allowable straight line rate of 10%. However, the company can sell the machine at the end of the

contract for $250,000 after incurring an additional cost of $24,000. The company has decided to

capitalise total renovation costs to new P&E.

RUNWELL will be in contract to supply 48,000 boxes of the parts per year and that will require

RUNWELL to operate at 80% of its capacity when variable operating cost will be 50% of sales.

Selling price per box will be $30. Annual fixed operating cost, excluding depreciation, will be

$160,000. It is estimated that the production line will operate at full capacity during the last four

years due to increasing demand. Variable operating cost at full capacity would be 45% of sales.

Existing section of the factory, where the new P&E will be installed, is in use by a subcontractor

who pays monthly rent of $2,500. Therefore, RUNWELL has to forgo the rent income once the

new production line commences its operation.

In addition to initial employee training cost of $26,000, there will be additional training expense

of $18,000 in the first year. It is also estimated that the new production line will require an

initial increased investment of $51,000 in stock and $23,000 in debtors that are offset by an

increase in creditors of $25,000.

The firm has a 14% weighted average cost of capital (WACC) and is subject to a 30% tax rate.

The required discounted payback period is 5 years.

The GM hesitates to take the final decision because of unexpected growth in car manufacturing

technology. RUNWELL has an offer to sell the contract to another compliant company for

$200,000. The GM also asks whether or not the discount rate should be increased to allow for

the risk of the above contract or is the WACC appropriate?

Required

Using Excel Spreadsheet prepare a full analysis to be presented to the GM of RUNWELL

Corporation evaluating whether the existing product line should be replaced by the new

product line. Your analysis should include the following

• Table of cash flows

• Use of excel formulae where appropriate

• A written report (1200 words, +/- 10%) outlining your recommendation as to whether

RUNWELL Corporation should proceed. Justify your recommendation and your analysis

of risk.

Marks will be awarded for:

• Set out of spreadsheet

i. Ease of reading spreadsheet

ii. Use of excel formulae in organised spreadsheet

iii. Correct application of theoretical model

• Overall presentation of answer including the written report.

* Carefully read the following Marking Rubric on page-3 for required components and

presentation of formal report.