Loop plc is a technology company based in Hertfordshire (United Kingdom), specializing in research and development of wireless electronic gaming gadgets. The company sells its products throughout the UK, Western Europe, South Korea, and USA. The company has developed a new portable games console (The Galactic Lite) that will be sold in these international markets. Thus, the firm will have cash flows denominated in, GB sterling £, € Euro, Won and US$ dollar. The unit figures given below are the sterling equivalent of these cash flows at current exchange rates. The British pound Sterling £ is expected to severely fluctuate against world currencies over the next 5 years.

The company spent £3,000,000 on R&D on the Galactic Lite wireless gadget in the past few years. Due to the rapid changing nature of the electronics gaming industry and the uncertainty surrounding rising inflation, recession in the world economies and impacts of the UK exiting the European Union, the company directors are faced with a dilemma of how to drive the new product forward. The directors are now faced with two mutually exclusive options to exploit the financial potential of the new product.

Proposal 1: Loop plc could go ahead and manufacture the electronic gaming gadget itself. The company will need to acquire new manufacturing equipment at a cost of £180 million. The equipment could be financed through a rights issue or bond issue and would be bought on the last day of the company’s current financial year. Investment in working capital will need to be £45,000,000 and this is recovered at the end of the project. The estimated scrap value of the equipment at the end of the production period is £1,000,000. Loop plc has a large warehouse which will be used as a factory for manufacturing the device. The warehouse is currently rented out to another company for £20,000,000 a year. Loop plc is set to sell the new product at £320 per unit (current price). Selling price inflation is expected to be 3% per year from the first year.

Variable cost is £160 per (current price). Variable cost inflation is expected to be 4% per year from the first year.

Marketing expenses including online advertising will be £30,000,000 (current price) a year subject to 2% inflation. Additional fixed costs will be £25,000,000 a year and not subject to inflation. Loop plc plans to use the straight-line depreciation method on manufacturing equipment. The directors set a target accounting rate of return on investment of 30 per cent and a payback period of three years for all projects. Loop plc estimates the future sales from next year onwards as follows (assuming a product life of 5 years due to competitions):

Year	Year 1	Year 2	Year 3	Year 4	Year 5
Number of units	500,000	1,200,000	1,500,000	2,000,000	600,000

Loop plc pays corporation tax at a rate of 20% per year, one year in arrears. Tax is paid on the operating cashflow(profit).

Loop plc pays corporation tax at the rate of 20% on its taxable profits which is paid one year in arrears. (Assume that operating cash flow is the same as taxable profit).

Ordinary Share Capital

A recent report by financial consultants suggests that the Loop plc’s equity has a beta of 1.4 and reported that medium-term UK government bonds are earning 2.89% per annum. In addition, the report noted that the FTSE All-share index returned an average of 11.6% in each of the last three years.

Loop plc ordinary shares are trading on the stock exchange at £1.65 whilst their debenture/bond is trading at £104.70.

Inspection of the Loop plc balance sheet reveals the following:

No of Shares

Ordinary shares par value £1 £20,000,000

•Debt Capital:

10% debentures are due to mature in 4 years at par. The current market value of each debenture is £104.70, and the total book value of the debentures is £5m.

8% irredeemable bonds are trading at £97. The interest has just been paid. There are £2m nominal value worth of irredeemable bonds, as per the statement of financial position.

•The corporation tax rate applicable is 20%.

Loop plc uses its Weighted average cost of capital as the cost of capital (discount factor)

Proposal 2: Loop plc could sell the patent rights to another business (Nitro Dynamic Ltd) that specialises in manufacturing electronic products for a fee of £70 million. It will be payable immediately in a one-off instalment. Loop Plc will not be allowed to manufacture any of the new products once the patent is sold.

Answer rating: 100% (QA)

Proposal 1 The first option for Loop plc is to manufacture the electronic gaming gadget itself This would involve the company acquiring new manufacturing equipment at a cost of 180 million as well as ... View the full answer