Capital Budgeting
You have just been appointed to the newly created position financial analyst position with the Australian company, Samphore Pty Ltd, which manufactures an innovative medical diagnostic test for breast cancer. Although the company has its operations in Australia, it was recently sold to a private equity company based in the United States whose shareholders are unable to utilise the value of the Australian Dividend franking credits. The new owners of Samphore Pty Ltd have just appointed a recently retired eminent pharmacological researcher to the head of the company. Yesterday, you received the following memo from this new CEO.
MEMO
To: Financial Analyst
From: CEO
Subject: New Product
The capital projects committee, which I chair, will be meeting soon to consider an investment to produce a new diagnostic test for prostate cancer that has recently been approved by the Australian health authorities. Although the regulatory approval to sell the test is five years, with an option to seek further approval after that time, the companies experience with other diagnostic tests is that it is likely to be superseded by a new test by the end of the initial five years. The following information has been provided by the accounting division with input from production and marketing.
Cost of new plant and equipment $7 900 000
Freight and installation costs $100 000
Estimated sales pattern
Year Number of units
70000
120000
140000
80000
60000
Sales price per unit $300/unit years 1 to 4; $260/unit in year 5
Cost of Sales $180 per unit
Annual fixed costs $200000
Depreciation prime-cost over 5 years with no salvage value
Working capital There will be an initial investment of $100 000 just to get the project underway. After that, extra investment will be necessary to bring the total of working capital up to 10% of the years estimated sales. This means that the total working capital will decrease from year 4. The final amount of working capital will…