Leo plc is considering entering a new market. A new product has been developed at a...

  

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Leo plc is considering entering a new market. A new product has been developed at a cost of £5 million and is now ready for production. The market is growing and estimates from the finance department concerning future sales of the new product are as follows: Year Sales £m 1 30.0 36.0 40.0 48.0 5 60.0 After Year 5, sales are expected to stabilise at the Year 5 level. You are informed that: ■ the operating profit margin from sales in the new market is likely to be a constant 20 per cent of sales revenue 234 2 the cash tax rate is 25 per cent of operating profit ■ replacement non-current asset investment (RNCAI) will be in line with the annual depre- ciation charge each year ■ additional non-current asset investment (ANCAI) over the next five years will be 15 per cent of sales growth ■ additional working capital investment (AWCI) over the next five years will be 10 per cent of sales growth. The business has a cost of capital of 12 per cent. The new market is considered to be no more risky than the markets in which the business already has a presence. Required: Using an SVA approach, indicate the effect of entering the new market on shareholder value. Leo plc is considering entering a new market. A new product has been developed at a cost of £5 million and is now ready for production. The market is growing and estimates from the finance department concerning future sales of the new product are as follows: Year Sales £m 1 30.0 36.0 40.0 48.0 5 60.0 After Year 5, sales are expected to stabilise at the Year 5 level. You are informed that: ■ the operating profit margin from sales in the new market is likely to be a constant 20 per cent of sales revenue 234 2 the cash tax rate is 25 per cent of operating profit ■ replacement non-current asset investment (RNCAI) will be in line with the annual depre- ciation charge each year ■ additional non-current asset investment (ANCAI) over the next five years will be 15 per cent of sales growth ■ additional working capital investment (AWCI) over the next five years will be 10 per cent of sales growth. The business has a cost of capital of 12 per cent. The new market is considered to be no more risky than the markets in which the business already has a presence. Required: Using an SVA approach, indicate the effect of entering the new market on shareholder value.

Answer rating: 100% (QA)

Solution Year 1 Sales revenue 30000000 Operating profits 30000000 20 6000000 Less Cash tax 6000000 2... View the full answer