Specimen answer

aidensmith2

New member
Hi,

I'm trying to find an example to an essay question which I post below. Provided it's similar is all I really need as I'm unsure how to proceed with regards to answering it.




Company A is considering producing a new product targeted at a market segment the company has identified as being potentially lucrative. The product will have a predicted market life of 10 years.

Capital investment of $10 million will be required. Accounting policy is to depreciate such investments over 10 years in equal instalments.

Weighted average cost of capital incurs a 6% risk premium to ascertain the discount rate for application in routine capital investment appraisal calculations. Management feels, however, that a rate of 10% may be more appropriate in this instance in light of the increased risk profile of the market segment.

Instead of “in-house” production, Company A could out-source production to another group company.

Management would like to know whether it is product to progress the project in the current financial climate, and how much additional cash flow and shareholder value added will be generated. They seek a financial analysis of the 10 year timeframe of the product.



Annual Sales Volume 2,000 units
Unit Selling Price $X
Unit Variable Costs $X
Fixed Costs (excluding depreciation) $X

Managers would also like a financial analysis for a pessimistic situation where sales are less than the 2,000 units and how this might affect any decision to invest.

Transfer price of £400 per unit. The contract will be for 2,000 units per annum. Where demand be less than this Company A must still purchase the contracted volume.

Equity: 50%; ordinary shares with a historic dividend rate of 4%
Debt: 50%; long term loans with interest rate of 6%



The answer must include the following.

Analysis of profitability, break-even analysis and cash flow over the 5 year product life.

Analysis of in-house production versus out-sourcing, including net present value and a sensitivity analysis.

Analysis of the theoretical financial calculations used, and how risk is considered.

Analysis of broader business considerations.
 
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