Photochemical reactor modeling: a case-study problem. Although radiation is important in heat transfer, an analogous model can be used in the design of photochemical reactors. The modeling of these reactors….
submit a summary of your analysis, along with your recommendations on the project, in a short memo.
XYZ Limited manufactures medical products. The company is considering adding a new product
(“Product X”) to its mix but the market for this product is thought to be riskier than the company’s
current operations. However, the Board of Directors is particularly interested in the product because
it has characteristics that meet their aim to become a more environmentally responsible business.
Having already spent significant funds ($1 million) on research and development of the product, the
company is now close to the final investment decision stage and the CEO has asked you to put together
the financial analysis of the project. You will submit a summary of your analysis, along with your
recommendations on the project, in a short memo.
A market research report commissioned by XYZ recommends producing and selling Product X for five
years as technological change will likely render the product obsolete after that time. Estimated annual
sales revenues for Product X in the first three years are expected to be $180 million. For each of years
4 and 5, sales revenues are expected to fall 30% on the prior year. The market research report stressed
Assessment 4: Case Study 2 ACC91210 SP4 2020
that the expected fall in revenue is subject to competition and technological advances and their
estimated 30% fall has a high standard deviation.
The product development team has estimated the following operating costs and net working capital
requirements associated with the project. Cost of goods sold is expected to equal 60% of sales
revenues. Selling, general and administrative expenses directly related to the project (excluding
depreciation) are expected to be $12 million in the first year and increase by 3% per year thereafter.
It is also expected that the project will require an amount of net working capital on hand equal to 20%
of each upcoming year’s sales revenue forecast. The investment in working capital will be fully
recovered by the end year 5 as the project winds down.
The project requires an upfront investment in plant and equipment. The company has already
received quotes on the plant and equipment costs and estimates a total of $150 million, which will be
depreciated to a zero book value using the prime cost method over the five-year life of the project.
XYZ plans to set up project operations in a factory it owns but currently leases to another company.
XYZ’s current pre-tax profit related to this lease is $2 million per year and XYZ budgets reveal a 3% per
year increase in this figure over the next five years, which aligns with external forecasts of rental
growth in the area.
At the end of the project, the plant will be dismantled and equipment sold. Dismantling costs are
expected to be $2 million. The estimated market value of the equipment at that time will depend on
its condition but a ballpark figure of $10 million has been estimated.
Other case information:
XYZ has a 10% weighted average cost of capital and pays a 30% tax rate. For the purpose of capital
budgeting, it is assumed all taxes are paid in the year of income to which they relate. The company is
expected to have taxable income from other projects that could be reduced by any losses on the
Product X project, which would reduce the firm’s overall tax in that year. The company is not eligible
for any research development tax deductions.
Prepare a financial analysis of the proposed project and present it to XYZ’s CEO in the form of a memo.
As part of your financial analysis you will calculate the five investment decision criteria detailed in the
Week 4 PERCI content.
In your memo, briefly explain and justify your chosen methods, inputs and any assumptions made,
summarise your findings and present recommendations on the proposed project that arise from your
analysis. Ensure you not only address base case cash flows but also analyse potential uncertainty.
Recommendations should address the decision to be made, along with any further follow up or other
matters the company should consider prior to making a final decision.
Include an appendix to the memo that includes your base case figures. Within the memo body, you
may provide tables and figures that assist decision makers understand your analysis, findings and their
implications for decision making but ensure the tables and figures are discussed and/or explained.