Strategic and Financial. Investment Decision-making.

Strategic and Financial Decision-making 
PW Communications plc is a relatively small public manufacturing company. The company plans to launch a new, high specification, electronic Notebook, known as the ‘Supreme A10’. The nature of the product is such that competitors are likely to join the market very quickly. For this reason, it is thought that the Supreme will have a five-year economic life.
At a Board meeting the Marketing Director, Sara Sparkes, suggests that forecast sales (in units) of the products will be 90,000, in Year one (2021), and that this will increase by 10% per annum up to, and including Year 4. In Year five, sales will be 60,000 units.
The budgeted costs of the product, for initial production, will be as follows, according to the Production Director, Jaypal Sangray:
Supreme
£/unit
Direct Materials 75.00
Fixed Production costs 45.00
Total full cost 120.00
Mark-up 36.00
Selling price 156.00
The incremental fixed production costs in the budget have been apportioned according to the initial units of output. As can be seen the company operates a cost-plus policy of 30% on total unit product cost.
In addition, to the fixed production overheads (costs) there will be £500,000 spent on advertising in the first year of launch, and then £200,000 in each subsequent year. There are no incremental non-production costs other then advertising, associated with the products.
At the Board meeting it becomes apparent that the new product will require an initial total investment of £7,500,000 on machinery and factory infrastructure. The machinery will have no identifiable value by the end of the product life cycle.
The following rates of inflation will apply from the first year onwards, with regard to the following data:
Selling Price 4%
Direct Material Cost 6%
Fixed production costs 5%
It is apparent that the applicable tax rate over the 5 years will be 25% per annum, payable in the year that the cash flow is earned. In the current tax regime there are no capital allowances available.
The general view at the Board meeting is that the project should be appraised using Net Present Value and Internal Rate of Return principles.
Linda Webster, the Assistant Finance Manager, who has recently completed an MSc International Business says to the board that. “We will need to know the weighted average cost of capital (WACC), as we will need a discount factor.”
To this end she indicated that the following information may help calculate the WACC:
As far as equity is concerned the company has paid the following total dividends over the last 7 years:
Year Total Dividends (£)
2014 488,000
2015 567,000
2016 675,000
2017 864,000
2018 927,000 
2019 1,102,000
2020 1,181,000 (forecast)
The company is currently financed by 6,000,000 (£1 shares), each with a market price of £4.70 ex div, along with £4,000,000 of 7% corporate bonds which are currently trading at £90 per £100 of bonds ex int. These bonds mature 5 years from now in 2025.
Before the end of the meeting, Claire Toogood, the HRM manager says, “When I was on a CIPD (Chartered Institute of Personnel and Development) course we were told that it is much easier to appraise projects using the Payback and Accounting Rate of Return methodologies.” There was no immediate response at the meeting as many of the members could not understand the conversation.
However, to complicate matters even further Linda Webster, who enjoyed the limelight, said, “When looking at our financial arrangements wouldn’t it be better to use more debt (corporate bonds) in our financial structure. This might make future projects look much more attractive.”
This suggestion was sufficient to hasten the meeting to an end.
 Required:
Working as a consultant to the board you should respond to the following tasks:
Task 1
Taking account of all of the relevant information in the above scenario you should calculate both the Net Present Value, of the proposed project and the Internal Rate of Return.
In addition, you should give an opinion as to whether or not the project is worthwhile. This may include factors beyond your calculations.
(20 marks)
Task 2
 Provide an analytical response to Claire Toogood’s comment, contrasting the methods above (Task 1) with her suggestions. This should be a written discussion and requires no additional calculations.
(15 marks)
Task 3
Stewart et al (2004, p3) state that ‘real options thinking’, “provides a map to navigate future strategic decisions which could impact value.”
You should provide a critical analysis of this statement considering how ‘real options thinking’ may provide an improved approach to strategic decisions than DCF/NPV, alone, This analysis should provide a general consideration of the value of ‘flexibility’ in decision-making and also consider how the pragmatic reference to the variables within the Black-Scholes option pricing model, may aid the creation of value.
Your discussions should relate specifically to the scenario above, concerning PW Communications.
(30 marks) Task 4 
Fletcher, H and Smith, D. (2004, p2) consider that, “the EVA (Economic Value Added) metric is not only a measure of financial performance but should serve as the centre piece of a strategy development.”
You are required to analyse the variables within the EVA model and consider what lessons this provides to they creation of value within long run capital investment projects (15 marks)
Task 5
Provide a well-argued response to Linda Webster’s final comments concerning capital structure. You should provide a well-researched response indicating whether or not you agree with her suggestion.
(20 marks)
(Total 100 marks)
References
Fletcher, H and Smith, D. (2004) ‘Managing for Value: Developing a Performance Measurement System Integrating Economic Value Added and the Balanced Scorecard in Strategic Planning’, Journal of Business Strategies, Vol. 21, Iss. 1, p1-17.
Stewart, R., Studley, J., Stokes, D., Vassallo, P. and Wells, P. (2004) ‘Understanding the options in Strategic decisions and investments’, The Journal of the Securities Institute of Australia, Iss. 2, Winter, p2-5. Further Information
You are required to present well-structured answers of no more than 3,500 words in total (excluding calculations).
Learning Outcomes Assessed:
• Recognise the role of accounting and finance within the strategic planning process
• Demonstrate problem solving and decision making skills through the selection and application of appropriate tools, and control processes, for strategic project appraisal
• Consider the importance of risk assessment at all stages of the investment process and the application of a variety of risk management techniques
• Appreciate the importance of the cost of capital, and the influences upon it, within the strategic investment appraisal process
Assignments will be graded according to the following criteria:
• The generic postgraduate assessment criteria, plus:
• Evidence of critical judgement in selecting, ordering and analysing content in order to present a sound argument.
• The demonstration and understanding of relevant concepts and models.
• The demonstration of insight and originality in responding to the assignment.
• The extent and level of research undertaken and the degree to which this research is appropriately referenced.
Important specific points to remember• Think about the question and the structure of your answer – you need a clearly defined structure which addresses the specific issues of the assignment. Therefore, PLAN your response very carefully before beginning to write. Think to yourself:
o What is the question asking me to do?o Is what I am writing focused on the question – is it relevant – or am I just including it because I found it!!?
• Make sure that you read all articles which are referred to in the assignment (if any)
• Start your work by looking through the relevant areas of your course notes
• Never write anything in your assignment that you do not understand
• Do not use ‘bullet points’ to any great extent – this tends to preclude analysis and explanation
• Think about presentationo Contents pageo Page numberso Use short sentenceso Use many short paragraphs – a new paragraph for each different idea.o Do not use too many headings – this tends to prevent the flow of the worko Where an assignment is divided into parts 1) 2) 3) etc. – answer in that format – do not merge answers - it is impossible for the assessor to mark these easily.o When you prepare calculations always show full, and comprehensive, workings
• When referencingo NEVER reference to Wikipedia, Investopedia, mbaessays.com, chaeatsrus.com etc – these websites are all unsubstantiated – the material on these can be written by anyone – ALWAYS use academic literature (journal articles, text books etc – these have been refereed by other academics) – unless you are looking on reliable websites for data and statisticso If you include a quote in “speech marks” you need to also include the page number from the source as well as the author name and date o All the references that appear in the script should appear in your Reference List – it is not a Bibliographyo The Reference List should be in alphabetical order by author surname (family name)