You are a senior recruiter at Best People, a recruitment agency. Mr. David Smith, the chief financial

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

Question:

You are a senior recruiter at Best People, a recruitment agency. Mr. David Smith, the chief financial officer (CFO) of Tasman Pulp Mill Co. (TPM), has just announced that he will retire in 6 months after 25 years at TPM. A long-term client of Best People, TPM is a Launceston headquartered, ASX-listed company that employs more than 1200 people across its diversified business units in Tasmania, where the overall unemployment rate is above 7.5%. The chair of the recruitment committee of the board of directors at TPM asks you to help find the next CFO who will be able to assist the chief executive officer (CEO) to continue the success and growth that TPM has seen over the last two decades or so. You indicate to the committee chair that, because TPM continues to expand its operations via either acquiring other businesses or upgrading current facilities, it is critically important the incoming CFO has thorough understanding of project analysis and capital budgeting. You also suggest that the best way to test the candidates’ knowledge and practical skills is to ask the candidates to analyze a simulated case in addition to the usual formal interview.

Part I (8 marks): The committee chair agrees with you and asks you to come up with a mock case. The information listed below will be given to the candidates.

(1) TPM has an after tax cost of capital of 11%; it will pay 8% on any new bank borrowing; the current tax rate is 30%.

(2) A new manufacturing technology has just become available. Adopting this new technology requires TPM to upgrade its manufacturing equipment. Compared to the existing technology, the new technology is faster and requires fewer workers but at the same time is less environmentally friendly.

3) The current pulp mill equipment has an annual output of 600,000 air dried tonnes (ADt) of pulp which currently sells at $125 per tonne. In contrast, the new equipment will have an annual output of 700,000 ADt of pulp. Annual demand is only 600,000 tonnes.

(4) The current equipment was purchased three years ago for $50,000,000. It has a book value of $29,000,000 and another four years of life remaining with no salvage value. It can be sold on the secondary market today for $12,000,000. The new equipment costs $76,000,000 (will be fully funded by bank loans) and is expected to last five years with an estimated salvage value of $16,000,000.

(5) The current equipment requires annual fixed cash costs (including overhead and operating) of $4,250,000, while the new equipment requires $3,790,000.

(6) Manufacturing pulp using the current equipment incurs the following costs (per tonne) in addition to the costs stated in (5): labour $34.5, material $35.5, variable overhead $15.25, and fixed overhead $17.5. The corresponding figures for the new equipment are $18.45, $29.20, $13.55, and $21.25, respectively.

All candidates are required to answer the following questions:

(a) From the perspective of capital budgeting, should TPM upgrade to the new technology or continue to operate using its current equipment?

(b) Conduct a sensitivity analysis) of adopting the new technology by considering specifically (i) that labour cost per tonne may be underestimated, (ii) that demand might be higher than 600,000.

Part II (5 marks): The committee chair also asks you to prepare a list of questions which will be used in the formal interview to test the candidates’ theoretical understanding of project analysis and capital budgeting. The Chair indicates that the number of questions should be ten. The Chair further indicates that the majority on the interview panel have no background in project analysis and capital budgeting; therefore they rely on the answers prepared by you to conduct the interview and select the most suitable candidate for the position of deputy CFO.