Vastap Pty Ltd had been working on developing a new type of vascular stapler that would allow
Question:
Vastap Pty Ltd had been working on developing a new type of vascular stapler that would allow many types of vascular repair, including heart bypass surgery, to be performed using keyhole techniques rather than major invasive surgery techniques. The research showed, after animal and human trials, that the device was both safe and effective. Its major benefits were the avoidance of 'open wound' techniques and absence of any leakage in stapled joins using the device. The major problem with achieving large scale adoption was the usual reticence of practitioners to adopt new technology.
The business analysis phase had just been completed - a Product Description had been written and a financial feasibility of the project had been undertaken. This financial feasibility undertook a high level analysis of the elements necessary to determine whether it was likely the product could be financially successful if it was put into the marketplace. The product development team thought that it would take two years to get the product ready for market launch and therefore the first sales would take place in year 3. Market research based their estimates of demand and market penetration on this assumption. An internal rate of return financial model, based on net cash flows, had been used to estimate the viability of the project. This model made year-on-year estimates for an initial period of five years and assumed a constant growth rate in cash flows thereafter.
Market research indicated that the product had global appeal, would find a ready market in highly developed countries, with further markets emerging in developing countries. It was therefore felt by the market research team that the product had great promise. In the economies that they thought should be entered immediately they estimated there would be a market of about 1 million units per annum.
In view of the fact that competitors were likely to respond strongly to Vastap's entry into their market the marketing team felt that market penetration would be relatively low, perhaps as little as 5% initially building to about 10% over the next three years. However, the figures indicated that something around this level might be sufficient to induce Vastap's ultimate decision makers to proceed with the product.
In addition to the marketing department's input into the financial model, the finance department had provided estimates of the likely capital costs needed, both to get the device into the market, and to fund capital replacement needs thereafter. The initial capital needed to complete development and get the product into the market would be one-off expenditure but the production equipment would have an initial life of three years, but thereafter replacement would be needed progressively on a five year rolling basis. The necessary investment in working capital had also been considered by the finance team. In making its estimates the finance team had considered the capital already spent on the project. The approach it had used was to calculate the value at the beginning of year 1 of all past annual expenditures. This single amount therefore represented the present value, as at the beginning of year 1, of all those past expenditures. Hence, that value would have to be recouped if the project was to be feasible.
Part of the finance team's brief was also to determine the ongoing annual product and period costs that would be incurred. These costings, together with the sales forecasts would determine the project's annual profitability. High level estimates were made; the expense groupings used were:
* Administration
* Promotion and marketing
* Selling and distribution
* Employee remuneration
* Cost of goods sold
* Regulatory costs
* Other
A contingency is also included to make allowance for forecasting error in expense items. Past projects have seen a contingency allowance of between 5% and 10% of total expenses.
The hurdle (discount) rate used to evaluate Vastap's new projects varied depending upon the risks associated with the particular project being evaluated. Whilst the firm's weighted average cost of capital (WACC) was 25%, project hurdle rates varied between 15% and 30%.
The final version of the financial feasibility is overleaf.
Required: You have been asked to identify the key success factors and risks associated with the project and to review its financial viability. How can I write a report to the senior management of the company setting out my views and giving a recommendation of whether the project should proceed.
Management Accounting
ISBN: 9780730369387
4th Edition
Authors: Leslie G. Eldenburg, Albie Brooks, Judy Oliver, Gillian Vesty, Rodney Dormer, Vijaya Murthy, Nick Pawsey