In order to increase its market penetration and boost profitability, Coles Group (COL) is evaluating investing in

Fantastic news! We've Found the answer you've been seeking!

Question:

In order to increase its market penetration and boost profitability, Coles Group (COL) is evaluating investing in a "Mega Automated Convenience Store" (MACS). COL has already identified a facility that could be ideal for this new format of convenience store. In order to mitigate the risk and assess the fit for purpose of the facility COL asked "Stem Consulting Ltd." to conduct a technical due diligence. "Stem Consulting Ltd." is asking $150,000 as a fixed fee for its consulting services. The MACS will have a size of 5,000 square meters (sqm) and will require an initial investment of $100 million. As part of the initial investment, COL will also have to invest additional $50 million in state of the art AI Robotics Technologies. It is believed that the MACS will be able to generate 20% more revenues compared to a traditional convenience store. The average annual sales per sqm of a traditional convenience store is $18,000. The MACS will generate revenue starting at the end of year 1 until the end of year 10. It will also incur additional working capital expenses of $5million immediately, this working capital will be recovered at the end of the project. It is believed that the MACS will reduce the revenues of a close grocery store that the company also own. The total impact on the annual revenues of this store is expected to be a reduction of $10 million. The management team is forecasting that operating costs will be only 15% of the incremental revenues from year 1-10. The initial investment will be depreciated on a straight-line basis over ten years to 0 book value. COL has estimated that the MACS can be sold at the end of year 10 for $15 million. The tax rate is 30%. All cash flows are annual and are received at the end of the year. The weighted average cost of capital is 5.5%.

a) Calculate the FCFs for this project.

b) What is the NPV for the project?

c) What is the Discounted Payback Period?

d) What is the IRR?

e) Assume that the risk of investing in the MACS is higher than the overall risk of the company, what would happen to the discount rate and consequently NPV of the project? Why?

f) Suppose that COL' management discounted payback rule is 5 years. Based on your analysis in b), c) and d) should the company undertake this project? Justify your answer with reference to theory. What other factor might affect the final decision?