Aftab Pty Ltd understands that these days, taking your business online is not a choice but a necessity. Aftab Pty Ltd's management team have brainstormed two options with the objective of maximising Aftab's value. It is expected that with the online presence, demand for their products would increase. As part of the management team and a financial analyst, you have been asked to investigate the viability of the different options. The two options A and B are outlined below. Option A: Build an online presence Aftab Pty Ltd's management is evaluating a proposal to invest in a modern network system to build up their online presence. The associated infrastructure of the new network would cost $500,000 (including installation costs) and has a useful life of 5 years. The infrastructure will be depreciated during these years as per the straight-line method and has no scrap value at the end of its life. The enhanced online presence due to the new network system would generate $56,000 per year in net profit over the next five years. To evaluate the above project, utilise the capital budgeting techniques that you have studied in this subject. For this purpose, you are recommended to use a required rate of return of 12%. Please note that no additional working capital is required for this project Option B: Outsource the online presence project overseas Aftab Pty Ltd is investigating an opportunity to outsource the online presence project to a developing country. Through the outsourcing program, it is expected that the total cash fixed cost will drop by $200,000. The cost reduction will be achieved through access to cheap call centre facilities. Aftab's current cost structure per annum (pre-outsourcing) is given in the table below: Number of units sold per annum 15,000 Sales price per unit $80 Variable cost per unit $38 Total cash fixed cost per annum $450,000 Total depreciation per annum $100,000 You have been asked to assess the above plans and present your recommendations. Print version: financial information for Option A & Option B 1 2 3 4 5 Option A Year 0 Financials Forecast ($) Sales Cost of Sales Gross Profit Cash fixed cost Depreciation Earnings before interest and taxes (EBIT) Income tax (30%) Net Income 1,200,000 570,000 630,000 450,000 100,000 80,000 24,000 56,000 1,200,000 570,000 630,000 450,000 100,000 80,000 24,000 56,000 1,200,000 570,000 630,000 450,000 100,000 80,000 24,000 56,000 1,200,000 570,000 630,000 450,000 100,000 80,000 24,000 56,000 1,200,000 570,000 630,000 450,000 100,000 80,000 24,000 56,000 D E F A B Option B Number of units produced per annum Sales price per unit Variable cost per unit Total cash fixed cost per annum Total depreciation per annum 15,000 $80 $38 $450,000 $100,000 Write a report for the management team that addresses points 1 to 4 below: 1. Complete a financial evaluation of Option A using both NPV and simple Payback Period (not the discounted payback) capital budgeting techniques. Discuss which one is better and why. Use the payback cut-off period of 2 years for the evaluation, and use 12% as the discount rate to calculate the NPV. In assessing Option A, your report should also consider a sensitivity analysis on the NPV for the discount rate changing from 12% to 17%. Investing in a new business or new mode of delivery can be classed as a 'risky investment'. How can the risk-return principle be applied here and, from a financial modelling point of view, how can the risks of the project be analysed? 2. Complete a critical assessment of Option B using break-even analysis. Calculate and evaluate the current accounting and cash break-even points of the business. Your analysis of Option B should then include the revised break-even points (both cash and accounting break-even points) considering the outsourcing option. Based on market research, you anticipate sales with the new outsourcing option to remain the same at 15,000 units. Comment on the financial and non-financial implications of Option B. 3. A further idea briefly discussed by Aftab's executive team (but not as an option) was to extend the payment terms for customers from 20 days to 30 days. What are the implications of increasing the payment terms of customers to the cash cycle? Discuss possible scenarios where providing an extended payment term could benefit Aftab Pty Ltd. 4. Based on your analysis in points 1 and 2, recommend either Option A or Option B, or both, to the Aftab management team. Your recommendation should also include a detailed limitations section covering the challenges of using NPV, Payback period and break-even points in the decision making. Aftab Pty Ltd understands that these days, taking your business online is not a choice but a necessity. Aftab Pty Ltd's management team have brainstormed two options with the objective of maximising Aftab's value. It is expected that with the online presence, demand for their products would increase. As part of the management team and a financial analyst, you have been asked to investigate the viability of the different options. The two options A and B are outlined below. Option A: Build an online presence Aftab Pty Ltd's management is evaluating a proposal to invest in a modern network system to build up their online presence. The associated infrastructure of the new network would cost $500,000 (including installation costs) and has a useful life of 5 years. The infrastructure will be depreciated during these years as per the straight-line method and has no scrap value at the end of its life. The enhanced online presence due to the new network system would generate $56,000 per year in net profit over the next five years. To evaluate the above project, utilise the capital budgeting techniques that you have studied in this subject. For this purpose, you are recommended to use a required rate of return of 12%. Please note that no additional working capital is required for this project Option B: Outsource the online presence project overseas Aftab Pty Ltd is investigating an opportunity to outsource the online presence project to a developing country. Through the outsourcing program, it is expected that the total cash fixed cost will drop by $200,000. The cost reduction will be achieved through access to cheap call centre facilities. Aftab's current cost structure per annum (pre-outsourcing) is given in the table below: Number of units sold per annum 15,000 Sales price per unit $80 Variable cost per unit $38 Total cash fixed cost per annum $450,000 Total depreciation per annum $100,000 You have been asked to assess the above plans and present your recommendations. Print version: financial information for Option A & Option B 1 2 3 4 5 Option A Year 0 Financials Forecast ($) Sales Cost of Sales Gross Profit Cash fixed cost Depreciation Earnings before interest and taxes (EBIT) Income tax (30%) Net Income 1,200,000 570,000 630,000 450,000 100,000 80,000 24,000 56,000 1,200,000 570,000 630,000 450,000 100,000 80,000 24,000 56,000 1,200,000 570,000 630,000 450,000 100,000 80,000 24,000 56,000 1,200,000 570,000 630,000 450,000 100,000 80,000 24,000 56,000 1,200,000 570,000 630,000 450,000 100,000 80,000 24,000 56,000 D E F A B Option B Number of units produced per annum Sales price per unit Variable cost per unit Total cash fixed cost per annum Total depreciation per annum 15,000 $80 $38 $450,000 $100,000 Write a report for the management team that addresses points 1 to 4 below: 1. Complete a financial evaluation of Option A using both NPV and simple Payback Period (not the discounted payback) capital budgeting techniques. Discuss which one is better and why. Use the payback cut-off period of 2 years for the evaluation, and use 12% as the discount rate to calculate the NPV. In assessing Option A, your report should also consider a sensitivity analysis on the NPV for the discount rate changing from 12% to 17%. Investing in a new business or new mode of delivery can be classed as a 'risky investment'. How can the risk-return principle be applied here and, from a financial modelling point of view, how can the risks of the project be analysed? 2. Complete a critical assessment of Option B using break-even analysis. Calculate and evaluate the current accounting and cash break-even points of the business. Your analysis of Option B should then include the revised break-even points (both cash and accounting break-even points) considering the outsourcing option. Based on market research, you anticipate sales with the new outsourcing option to remain the same at 15,000 units. Comment on the financial and non-financial implications of Option B. 3. A further idea briefly discussed by Aftab's executive team (but not as an option) was to extend the payment terms for customers from 20 days to 30 days. What are the implications of increasing the payment terms of customers to the cash cycle? Discuss possible scenarios where providing an extended payment term could benefit Aftab Pty Ltd. 4. Based on your analysis in points 1 and 2, recommend either Option A or Option B, or both, to the Aftab management team. Your recommendation should also include a detailed limitations section covering the challenges of using NPV, Payback period and break-even points in the decision making