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雷达卡
Logic plc is a large manufacturing company, based in the
It is organized on a divisional basis and requires each of its divisions to achieve a rate of return on capital employed of at least 10% per annum. The company defines capital employed as fixed capital(assets) and investments in stocks. The rate of return is also applied as the acceptance criterion in new investment projects. Logic plc supplies all funds to subsidiaries who have very limited powers to raise fundsexternally.
Info Tech Itd is a division of Logic pla\c and at the moment is considering an investment in a new advanced technology moulding machine. The new machine will contribute greatly to the desired flexibility in production and will also enhance quality. The equipment has a budgeted cost of ₤21m and it is expected to have a residual value of ₤3m and it is thought that it could be sold to a competitor who operates in
The new machine will be capable of increasing Info Tech’s prodection volume which is desirable as it is thought that the market is growing, although, at the same time becoming increasingly competitive.
The anticipated additional sales arising out of purchasing the new machine are as follows:
Year 1 2,100,000 units
Year 2 1,900,000 units
Year 3 1,600,000 units
Year 4 1,600,000 units
As can be seen from the above information it is thought that the additional sales will gradually decline due to the increased competition. In fact it is thought that the Info Tech will have to reduce price by ₤0.75 per unit each year, from the original ₤7.5 proposed for Year 1, in order to even maintain this position.
The operating costs are anticipated as initially being ₤1.50 per unit but it is thought that these will suffer inflation of 5% per annum, which is slightly above the predicted general retail price index of 4% per annum.
The production of the new machine will also attract a charge for fixed overheads based on ₤1.10 per unit. It is thought that this will be held constant over the four years.
The increased level of production will nessitate an additional investment in stocks of ₤0.75m, which will be held t\at this level until the machine is sold.
At the same time as the investment is being considered there is a debate going on in the company, as a whole, as to what is the most appropriate method for appraising capital projects.
The new assistant management accountant (Bob Patton) at Logic plc is heard to say, “I can’t understand why we are using the average accounting rate of return as our decision making tool. I was always told that there are better methodologies that can be used.”
After further contemplation the management of Logic come to the conclusion that it may be better to use Net Present Value (NPV) as their project appraisal method.
Bob Patton, still keen to impress, then starts to think again. This time he says, “ I believe that we could increase the NPV of the project if we reduced our Weighted Average Cost of Capital (WACC). For instance, our debt holders are content with an average return of 6.5% whilst our shareholders are looking for a return in the region of 13.5%. Therefore, it would seem obvious that if the finance ourselves with a larger proportion of debt we will be able to reduce our WACC.”
This confusion over capital appraisal methodologies has also raised further concerns with Barry Russell the Operations Director at Logic plc. He feels that it is becoming ever more difficult to control the management teams at subsidiary level from Head Office and he voices his opinion as follows at an informal meeting of the Bord,” it would be better if developed strategies to control the divisional management.”
As the Board is raising these problematic issue they decide to employ a company of consultants in order to gain an objective view on matters and to take a step forward with regard to corporate policies.
The following is an extract of Info Tech Itd’s most recent divisional accounts:
Profit and Loss Account for the year ended
₤m
Turnover 180
Cost of sales (150)
30
Operating Profit 30
Balance sheet as at 31 march 2004
₤m
₤m
Fixed Assets (Net Booking Value) 68
Current Assets (including stocks of ₤38m) 48
Current Liabilities 20
Net Assets employed 130
calculate the NPV and Provide specific advice to the company.
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