ACCT 621 Accounting for Managers- Group Assignment – Planning for Capital Investments
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Group 1 – HILLWOOD GOLF CLUB CASE
James was recently recruited as the Financial Manager in Hillwood Golf Club. He initially worked as a junior executive in a for-profit organization for a period of 5 years before being employed at Hillwood Golf Club. James has had no prior experience dealing with financial matters and doesn’t want to make any mistakes. Therefore, James requires a detailed report from you, a talented group of MBA students, before finalizing any significant decisions.
Hillwood Golf Club was founded in 1945, serving golfers of all ages for the past 76 years. It once used to be the go-to place for the best recreational experience in Toronto in the past few decades. However, it has seen its membership decrease to other clubs and recreation providers over the past few years. In an attempt to attract new members and retain existing members, the founders of the golf club are considering building a golf driving range and an outdoor swimming pool. The founders hope to stick to their core values of being the provider of the best recreational experience, meaning the new project should not diminish the quality of the said experience.
James has been tasked to evaluate the proposed expansion from a financial perspective. The project would require an initial expenditure of $500,000. The club has agreed to sell the driving range and swimming pool for $50,000 at the end of 8 years. Furthermore, a survey has been commissioned at the cost of $70,000 to research the current recreational experiences market.
As the project progresses, the club will expect certain operating costs and revenues on an annual basis. Such an annual income would be the income of $300,000 received as Membership fees.
The fees are payable at the end of each year. Additionally, the club plans to host an annual fundraiser every December to raise an additional income of $120,000 to support the project. The project can be expected to incur specific overheads of $250,000 annually (this figure does not include depreciation). Furthermore, the club will incur an annual $50,000 as rent for the land where the buildings are being constructed.
Upon partial completion of the project in Year 4, a cost of $25,000 will be incurred as payment to a Canadian association for inspection of the buildings being constructed. A similar charge will be incurred at the end of the project.
The club generally considers non-financial factors when evaluating projects of this nature. It can be assumed that the number of members will be unchanged for the project’s life. The club uses a cost of capital of 8% per annum to evaluate projects of this type.
Required:
Prepare a report on the following for James;
a). Analyze what aspects are considered when determining a relevant cost of capital for evaluating the proposed project AND how a cost of capital supports evaluations of this nature.
b). Evaluation of the proposed project from a financial perspective. You should use net present value (NPV) as your evaluation basis and show your workings in $000.
c). Calculate the internal rate of return (IRR) of the project and mention few practical limitations using IRR for this investment decision.
d). Explain in detail ONE critical factor that the club has not considered in capital budgeting decisions concerning this project.
e). Interpret TWO non-financial factors that the club should consider before making a final decision.
f). Challenge TWO general assumptions we use in capital budgeting that would not be the best to make concerning this project.
Group 2-EHCH MOBILES CASE
Ellen was recently promoted to the position of Financial Manager in EHCH Mobiles. She initially worked as a junior financial executive for 3 years before being promoted. Ellen has had no prior experience dealing with significant financial matters and doesn’t want to make any mistakes. Therefore, Ellen requires a detailed report from you, a talented group of MBA students, before finalizing any significant decisions.
EHCH Mobiles has been in the mobile phone industry for the past two decades. The mobile phones produced by EHCH Mobiles have been compared to superior brands such as Nokia, Samsung. However, sales for their most successful brands had been declining for newer brands produced by these competitors in the past years. Therefore, the company is now considering the launch of a new 5G mobile phone. Experience from the sale of previous models has shown that the expected life of the new model is four years.
The company’s research and development division, which functions on an annual budget of $50,000,000, has developed a prototype of the new model. A further investment of $800,000,000 will be required at the start of year 1 for a new manufacturing facility to put the new model into production. The new manufacturing facility will be expected to have a residual value of$125,000,000 at the end of four years.
As the new model is being sold in the market, the company will expect to incur certain operating costs. The new manufacturing facility will exclusively produce the 5G model. The total fixed manufacturing costs will be $600,000,000 annually, excluding depreciation. It is also anticipated that an additional $200,000,000 will be spent in year 1 and $150,000,000 in years 2 and 3 on further development and marketing of the new model. The new model is to be marketed at a premium price of $300 per unit and is expected to remain the same throughout its life. Annual sales will amount to a total of 2,000,000 units.
The company is considering a large-scale convention at the end of year 1 to promote the new model to attract customers. The convention has been estimated to incur a cost of $5,000,000 and an additional $1,000,000 for marketing. The company believes that sales will likely boost to 3,000,000 units per annum from year 2 onwards.
Ellen has been tasked to evaluate the proposed expansion from a financial perspective. The company generally evaluates projects of this nature upon completion as well. The company uses a cost of capital of 7% per annum to evaluate projects of this type.
Required:
Prepare a report on the following for Ellen;
- Calculate the net present value (NPV) of the Workings should be shown in $000.
- Determine the profitability index (PI) and payback period of the project.
- Analyze why the project’s payback period is not the best method to assess the project from a financial perspective AND how the best method should be determined.
- Interpret TWO reasons why EHCH Mobiles may want to calculate the profitability index of this project even though NPV is the theoretically superior method of capital budgeting.
- Justify TWO reasons and TWO benefits of EHCH Mobiles carrying out a post- completion audit of this project.
- Assume the NPV for this project was positive but the decision maker decided not to go ahead with the project. Considering the nature of the business, provide possible reasons for the former decision.
Group 3- MCKINSEY AUTOPARKS CASE
Charles was recently promoted to the position of Assistant Financial Manager in McKinsey Autoparks. He answers to his boss, Jane, who is the Financial Manager of McKinsey Autoparks. Currently, Charles has become acting Financial Manager until Jane returns from maternity leave. Charles has had no prior experience dealing with significant financial matters and doesn’t want to make any mistakes. Therefore, Charles requires a detailed report from you, a talented group of MBA students, before finalizing any significant decisions.
McKinsey Autoparks is a company that provides parking services to many Canadians in British Columbia. It thrived significantly in the past decade, earning revenue from almost 10,000 cars weekly. However, in the wake of climate change and improved public transportation, McKinsey Auto parks sees a steady decline in revenues. Therefore, they are considering purchasing a piece of land close to a major airport situated in Victoria.
The land will be used to provide 800 car parking spaces. The cost of the land is $4,500,000. However, a further expenditure of $1,500,000 will be required immediately to develop the land to provide access roads and suitable surfacing for car parking. The company is planning to operate the car park for seven years, after which the land will be sold for $20,000,000 at Year 7 prices.
A consultant has prepared a report detailing operating revenues and costs projected from this project. It can be estimated that the proposed car park will operate at 90% capacity during each year of the project. Car parking charges will be $60 per car, and it is assumed to remain the same for the entire project period.
As there is a significant distance of 3 kilometers from the proposed car park to the airport, the company will be leasing several buses to transport passengers to and from the airport. The lease costs are expected to be $85,000 per annum. The company will also require staff to maintain the proposed car park and usher passengers to the relevant bus to drop them off at the critical access point. $475,000 per annum will be needed to retain and provide this staff with their necessary salaries and benefits. The company will also hire a security system to protect the vehicles parked at the cost of $130,000 per annum.
The company uses net present value when evaluating projects of this type. McKinsey Autoparks has a money cost of capital of 10% per annum. All cash flows apart from the initial investment of $4,500,000 can be assumed to occur at the end of the year.
Charles has been tasked to evaluate the proposed expansion from a financial perspective. The company generally considers non-financial factors when evaluating projects of this nature.
Required:
Prepare a report on the following for Charles;
- Evaluate the project from a financial perspective. You should use net present value (NPV) as the basis of your evaluation and show your workings in $000.
- Justify why the net present value method is considered the theoretically superior method in capital budgeting AND why other methods are unsuitable for this project.
- Calculate the internal rate of return (IRR) of the project and provide reasons as to why the decision make would refuse to go ahead with the investment although the IRR is lucrative
- Interpret the THREE elements that determine the ‘time value of money’ AND why it is essential to take it into consideration when appraising investment projects.
- Explain in detail TWO non-financial factors McKinsey Autopark should consider to refuse going ahead with the project.
Group 4 -GRAND FOREST HOTEL CASE
Natasha was recently recruited as the Financial Manager of Grand Forest Hotel. She has had enough experience in the hospitality industry to take up this role. However, she had a hiatus of two years between her previous job and this job to focus on her personal life. Therefore, she has had no recent experience dealing with significant financial matters and doesn’t want to make any mistakes. Therefore, Natasha requires a detailed report from you, a talented group of MBA students, before finalizing any significant decisions.
Grand Forest Hotel (GFH) is a five-star hotel situated in the heart of Alberta. In the past 80 years, GFH has made a name as the destination for anyone traveling through Edmonton.
However, GFH has lost revenue to upcoming competitors who provide more state-of-the-art facilities to its guests. Therefore, GFH’s management is considering expanding its facilities by providing a gymnasium and spa for guest use. The additional facilities are expected to increase the hotel’s occupancy rate and the rates charged for each room available.
The cost of refurbishing the space required for the new spa, currently used as a library for guests, and installing the spa is estimated to be $300,000. The gymnasium equipment is expected to cost $65,000. Every five years, the gymnasium and spa will need to be refurbished and the equipment replaced. The equipment will be sold for an amount of $12,500 at the end of year 5.
A feasibility report was produced by the hotel’s accountants at the cost of $15,000. The information has determined 82% as the current occupancy rate. A number of 65 rooms are available to guests staying at GFH, with $200 being the average room rate per night. It is expected that following the opening of the gymnasium and spa, occupancy rates would rise to 85%, excluding inflation. The hotel is set to be open for 360 days per year.
Throughout the project period, the proposed gymnasium and spa will employ 6 employees. GFH is expected to pay these employees an average salary of $45,000 per annum. The current budgeted specific overheads required for the gymnasium and spa is $250,000 per annum. As a direct result of opening the gymnasium and spa, the hotel’s overheads are expected to increase by $98,000. The company uses a money cost of capital of 12% per annum to evaluate projects of this type.
Natasha has been tasked to evaluate the proposed expansion from a financial perspective. The company generally evaluates projects of this nature upon completion as well.
Required:
Prepare a report on the following for Natasha;
- Challenge THREE general assumptions we use in capital budgeting that would not be the best to make concerning the proposed project.
- Analyze TWO aspects considered when determining a relevant cost of capital for evaluation of the proposed project.
- Calculate the net present value (NPV) of the gymnasium and spa Workings should be shown in $000.
- Justify TWO potential difficulties in using the net present value method in capital budgeting AND ONE possible workaround such difficulties.
- Calculate the discounted payback period (DPP) for the proposed project and assume the DPP was lucrative, and the decision maker decided not to go ahead with the Give reasons for the former decision.
Group 5 – ROYAL APPARELS CASE
Daniel was recently recruited as the Financial Manager of Royal Apparels. He previously served as a junior financial executive in a similar company for the past 4 years, where he primarily focused on more operational, financial matters. Therefore, he has had no experience dealing with significant financial matters and doesn’t want to make any mistakes. Therefore, Daniel requires a detailed report from you, a talented group of MBA students, before finalizing any significant decisions.
Royal Apparels is a major retail company which sells its ‘own brand’ products. It was established in 2003 and has found quick success in the Canadian apparel market. However, the company is now contemplating whether to capture a rapidly expanding overseas market by opening new retail outlets. Past experience from entering other overseas markets has shown that several factors would decide the brand’s acceptance. The potential of the market for the future can be indicated in sales for the first five years.
How the brand would be accepted will likely determine year 1 sales. A cost of $500,000 was incurred to employ a consultancy firm with experience in the overseas market, to provide detailed information on the market, and to estimate the likelihood of brand acceptance. The consultancy firm estimated that there is a high chance that the brand will be well received, and sales in year 1 will be $125,000,000. Sales are then expected to increase by $50,000,000 annually.
In order to develop and fit out the retail outlets, an investment of $75,000,000 is required. It is expected that the retail outlets will have a residual value of $15,000,000 at the end of five years. A further $2,000,000 will be required for working capital.
Fixed costs relating to the retail outlets, excluding depreciation, are expected to be $65,000,000 per annum and remain the same for the five-year period. It is also anticipated that a further $25,000,000 will be spent on marketing the brand in each of the five years. Furthermore, the company will have to pay $900,000 and $650,000 in Year 1 to the relevant Canadian and international authorities, respectively, as permit fees. An additional $400,000 will be incurred annually as salary and benefit payments for employees employed at each retail outlet. The company also has planned to incur an amount of $1,200,000 for the annual maintenance of each retail outlet. The company uses a cost of capital of 9% per annum to evaluate projects of this type. Daniel has been tasked to advise the company’s directors whether they should go ahead with the investment from a financial perspective. The company generally evaluates projects of this nature upon completion as well.
Required:
Prepare a report on the following for Daniel;
- Advise the directors of the company whether they should go ahead with the investment from a financial You should use net present value (NPV) as the basis of your evaluation. Workings should be shown in $000.
- Justify TWO benefits and TWO challenges of carrying out a sensitivity analysis before making investment decisions.
- Calculate the payback period and profitability index (PI) of the project.
- Interpret TWO reasons why the company’s management could be interested in the payback period of a project.
- Analyze TWO benefits of carrying out a post-completion audit of the proposed expansion AND how the process can be utilized for future projects.
- Assume the NPV for this project was positive but the decision maker decided not go ahead with the Considering the nature of the business, provide possible reasons for the former decision.