Wise Construction Limited – Old Machine and New Machine Cash Flows – Finance Assessment Answer

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Finance Assessment Answer
TASK:
Question
Wise Construction Limited is seeking to upgrade its ageing tunnel boring machine (TBM). The ageing machine is still able to excavate to capacity and excavate approximately 15 to 20 metres of tunnel boring per day on average. Due to its age, the old machine requires numerous skilled and un-skilled labourers to operate the machine, remove the excavated
materials, and provide other supporting roles. A new TBM with the same excavating capability has recently entered the TBM market. Due to technological improvements, the new machine claims to be far less reliant on both skilled and un-skilled labourers required to support and operate the machine. The sellers claim the new machine can provide a 50% reduction in both
skilled and unskilled labourers to operate the machine. The new machine will cost $12,000,000. Additional ongoing costs of $150,000 p.a. are required each year to train two skilled labourers to operate the new machine. Both costs are paid at the beginning of the project (t=0).
As the Chief Financial Officer (CFO), you are required to examine the financial viability of buying the new machine or continuing with the old machine. As the new machine provides the same excavating capabilities as the old machine, there is no expected change to the revenue stream. Your analysis should focus only on an incremental comparison analysis of the costs of buying the new machine versus the costs of continuing with the old machine. The following tables provide the relevant data for your analysis.
Finance Assessment Answer
Finance Assessment
Finance Assessment Answer
Table 3
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Part A
Using the data provided in the tables above – you are required to:
a) Calculate the NPV of buying the new machine
b) Calculate the NPV of continuing with the old machine
c) Based on your NPV analysis above what would you recommend to management?
d) Provide a brief discussion on the differences in NPV’s, and why you chose to recommend
1) buy the new machine or 2) keep the old machine
Part B
In light of the results obtained in your NPV analyses in Question 1 above, management has requested you undertake some further analysis to assist them in making a final decision. They have identified four main issues that they are concerned with might influence the NPV results obtained earlier. These include:

The impact of a 1% increase in the company’s WACC.

An ongoing dispute between the firm and the TBM Union suggests that an increase in salary growth might occur. All staff would then receive a 5% growth in annual salary.

Management has some concern that the estimated sale price of the new machine would only be $3,000,000 at the time of sale.

Management has also requested that you examine the impact on the NPV analysis if all
four issues above occur together.

You are required to undertake a sensitivity analysis of the following:
a) An increase in the firm’s WACC of 1%. Briefly describe what happened and why you think this happened.
b) The impact of a change in the current tax rate if the firm qualifies as a base rate entity. Briefly describe what happened and why you think this happened.
c) Unions win their battle and secure growth in all staff salaries to 5% p.a. Briefly describe what happened and why you think this happened.
d) A change in the sale price of the new machine to $3,000,000. Briefly describe what happened and why you think this happened.
e) The impact if all four factors occur together. Briefly describe what happened and why you think this happened.
f)Briefly discuss the results obtained from undertaking your NPV sensitivity analyses above. In light of your results are there any other factors you think the management team might need to consider before making a final decision (these could include a
need for further analysis and robustness checks and/or possibly include a discussion of more subjective issues that may assist management in making their final decision.

Question 2
You are considering investing in Australian shares and decide to investigate the shares of two Australian companies: RIO Tinto Limited (RIO) and Woolworths Group Limited (WOW).
For this question please note:
• Use the Yahoo! Finance website at http://au.finance.yahoo.com/ for data.
• This question is to be done on a spreadsheet with the results pasted and submitted in one Word document. Make sure that you show all your workings – for example, do not simply put down the covariance but show how it was obtained and this does not mean giving the Excel algorithm.

Please do not give cell formulae, cell references, etc, as the reader should be able to follow from a table. Also please note using excel formula such as =COVAR() is not acceptable. As you must submit all questions in one word document you cannot submit a spreadsheet, neither can you submit a spreadsheet as an embedded object in a Word document.

So after you construct your table in Excel please simply copy and paste into a Word document and remember to include all workings.
a. Find the monthly opening and closing prices for the period 1 January 2018 – 31 December 2018 for RIO, WOW and the Market as proxied by the All Ordinaries index (^AORD).
b. Calculate monthly holding period returns (%) for the period 1 January 2018 – 31 December 2018 for RIO, WOW and the Market. The monthly holding period return is the percentage return you would receive if you bought an asset on the first day of the month (opening price) and sold it on the last day of the month (closing price). (Use ‘Close’ rather than ‘Adjusted Close’ for
the selling price and include any dividends). Show the formula and at least one sample calculation.
c. Graph your results on one graph with returns on the y axis and time on the x axis.
d. Calculate the standard deviation of monthly holding period returns for RIO, WOW and Market.
e. Calculate the annual holding period returns for RIO, WOW and Market.
f. Calculate the covariances between RIO, WOW, RIO & Market, and WOW & Market over the year.
g. Calculate the beta of both RIO and WOW.
h. If average T bill rates in the year of 2018 were 2. 5% what would be the expected return of RIO and WOW according to CAPM?
i. Identify and explain if RIO and WOW were fairly priced or not in 2018.
j. Incorporating all the analysis explain which asset or combination of assets would you choose to invest in as a rational investor.
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