Business Finance Group Assignment Case Study

T2, 2014 Capital Budgeting – AusSteel Ltd

Introduction
This assignment is to be submitted in the form of a report of not more than 3,000 words.
It consists of eight questions, some generally relate to Capital Budgeting. Other questions ask you to
respond to capital budgeting aspects of the AusSteel case study.
The assignment has a weighting of 30% of your overall mark for the unit. The assignmen t allocates
100 marks across the eight questions. Your group mark will be converted to a score out of 30. All
members of the group will receive the same mark.
All students should have been enrolled in a group (of 3 – 4 students) to submit the assignment o n
CloudDeakin. You can from a group with any student from any campus, cohort or seminar group.
The only requirement is that all members should be currently enrolled in Trimester 2, 2014 offering
of MAF 203 .
It is up to the group to manage the group dynami cs and get equal contribution from all members. It
is a good idea to appoint a leader to direct and coordinate the activities of the group , including
allocating tasks (questions) among the group members. All group members are expected to discuss
the assignment as a whole and contribute to prepar ing answers to   all   questions. Before the final
submission of the assignment all group members are expected to review and edit all questions, as
appropriate . Only one member of the group should submit the assignment on CloudDeakin on
behalf of all the group members.
Only one file ( Word document or PDF ) should be uploaded for your group on the MAF203
CloudDeakin site.   List the names and ID numbers of all group members on the first page of your
Word document.
If you ar e using an Excel spreadsheet for NPV and IRR analysis, you need to copy and paste the
spreadsheets to the body of your Word document.    Alternatively print out the narrative pages (from
Word doc) and the spreadsheets (from Excel file) and scan them into a single PDF which can be
uploaded.   Please do not upload Excel spread sheets as a separate file.
Assignments sent as e-mail attachments or by mail will not be accepted under any circumstances.
Following is a summary of assignment requirements and guidance:
Question   Heading Marks Words
(indicative)
Comments
1 Rules for identifying f ree Cash
Flows (FCF)
10 6 00 General capital budgeting
2 Interest cost and D iscounted
Cash Flows (DCF)
5 2 00 General capital budgeting
3 Compare and contrast Net
Present Value (NPV) and
Internal Rate of Return (IRR)
10 6 00 General capital budgeting
As the a uthor, the copyright of this   case study (assignment) remains with Samson Ekanayake    Page 1

MAF 203 – Business Finance Group Assignment Case Study
T2, 2014 Capital Budgeting – AusSteel Ltd
4 Prepare cash flow statements
and compute NPV and IRR
20 n/a AusSteel case study
5 (a) Techniques of Project risk
analysis
(b) Sensitivity analysis
5

15
(a) 300

(b) n/a
(a) General capital budgeting.

(b) AusSteel case study.
6 Qualitative risk factors   15 5 00 AusSteel case study *
7 Weighted Average Cost of
Capital (WACC)
10 4 00 General capital budgeting, and
AusSteel case study.
8 Executive Summary
(recommendation)
10 4 00 AusSteel case study
TOTAL     100 3,000
*   The companion   document titled “Steel Has Never Been More Competitive”   published by the
Australian Steel Institute should also be used in forming your opinions when evaluating the
qualitative risk factors relevant to the new project (i.e . in answering question 6).
Points to note:
1.   You need to compare the benefits and costs of   continuing to use the existing machinery and
equipment with the proposed new machinery and equipment.
2.   For cash flow and NPV comparison you may adopt an incremental analysis (i.e. differential
analysis) or an isolation approach (holistic analysis). However , for this project an
‘incremental analysis approach’ is more appropriate as you may not have all the information
you require for a ‘holistic analysis’.
3.   If you make any assumptions, please state such assumption clearly.   Your assumptions, if
any, should be   realistic and should be only about information you need, but is not available
in the assignment documents.
Detailed Requirements
1.   Free Cash Flows (FCF)
(10 marks, 600 words –   indicative)
In this Unit we introduced you to five general rules for isolating and identify ing the Free Cash
Flows (FCFs) specific to an individual project.
List and briefly explain, in your own words and with examples , what i s meant by each of these
rules.
2.   Discounted Cash Flows (DCF)
( 5   marks, 2 00 words – indicative)
In project   evaluation, when   using Discounted Cash Flow (DCF) methods ( for example , NPV and
IRR),   we do not consider the interest cost on funds (t hat will be borrowed to finance the
project )   as a cash outflow relevant to the project.
Explain the rationale for ignori ng interest costs   in   DCF project evaluation methods.
As the a uthor, the copyright of this   case study (assignment) remains with Samson Ekanayake    Page 2

MAF 203 – Business Finance   Group Assignment   Case Study
T2, 2014    Capital Budgeting –   AusSteel Ltd
3.   Net Present Value (NPV) and Internal Rate of Return (IRR)
( 10 marks, 600 words –   indicative )
Compare and contrast NPV and IRR methods of project evaluation.
Explain why NPV method is considered superior to IRR method.

For questions 4 to 6 your group will need to e valuate the capital expenditure project currently
being considered by the management of AusSteel Company   Ltd (see case study details below).
4 . Net Present Value (NPV) and Internal Rate of Return (IRR)
(20 marks, w ord limit not applicable. However, cash flow statements should be efficient and
presentable)
Prepare cash flow statement/s and compute NPV and IRR for the proposed project.
5 . Net Present Value (NPV) and Internal Rate of Return (IRR)
(20 marks. W ord limit for ( 5 a), 300 words. Word limit for (5 b)   not applicable , h owever cash
flow statements should be efficient and presentable)
5(a)   What are the formal techniques available for identifying and evaluating the riskiness of a
project?   Briefly explain three of such techniques.
5(b)   Perform a sensitivity analysis on NPV of the new project,   applying a +/-10% variation factor to
the estimates for output and sales, selling price, variab le costs, fixed overhead costs,
incremental working capital and applicable discount rate.
Identify the most sensitive variable/s.
6 . Qualitative risk factors
( 15 marks, 400 words –   indicative )
Refer to t he companion   document titled “Steel Has Never Been Mo re Competitive” published by
the Australian Steel Institute .
What other qualitative factors (i.e. factors which are unquantifiable at present) would you
consider relevant in evaluating the riskiness of the project .
7 . Weighted Average Cost of Capital (WACC)
( 10 marks, 400 words –   indicative )
Under what circumstances (conditions) is it appropriate to use the weighted average cost of
capital (WACC) of a company, as the hurdle rate for accepting/rejecting a project ?
Do you think it is appropriate to use WACC as the hurdle rate (cost of capital) for evaluating this
project? Why?
8 . Executive Summary (recommendation )
( 10 marks, 400 words –   indicative )
Write your recommendation (with reasons), in a form of an executive summary, on whether to
accept or reject the project .
As the a uthor, the copyright of this   case study (assignment) remains with Samson Ekanayake    Page 3

MAF 203 – Business Finance   Group Assignment   Case Study
T2, 2014    Capital Budgeting –   AusSteel Ltd
Case Study – AusSteel
AusSteel Company Ltd (AusSteel), based in Victoria, is cons idering investing in a project to replace its
current machinery and equipment   being used in fabricating base steel. De spite the current
stagnated prices in the fabricated base steel market (which are at 2007 levels) , AusSteel   belie ves
that current price levels are still profitable and that the market is likely to   improve in the near future .
The CEO of AusSteel firmly believes that the enterprise   should invest in capital assets now   to ensure
that they will be around tomorrow. The director of marketing also believes that the company should
invest in latest technology and machinery to maintain market share, otherwise “we are going to be
bypassed”.
On the other hand, the director of finance, who is well aware of the possible financial repercussions
of committing a huge amount of capital in new technology   and machinery, insists that the   new
machinery, if purchased, should generate positive net cash flows and increase the value of the
company. “ Otherwise, the shareholders would not be happy ” .
AusSteel’s manufacturing process , at present, is semi -automatic and considered environmentally
friendly as it consumes less energy.   The machinery and equipment currently being used on the
manufacturing site cost $50,000,000   five years ago and   has a written down value of $25,000,000.
The demand for the products has been fairly stable and o utput has been maintained at 5 00,000 tons
per annum in recent years. It is expected that the output and sales w ill increase to 550,000 tons if
the proposed new machinery and equipment are purchased and installed.
The accountant of the company has prepared the following data, based on the current level of
output, and existing machiner y and equipment:
Selling Price per ton $1,250
Variable expenses –   per ton manufactured and sold $   1,000
Fixed overhead expenses
excluding depreciation of machinery and equipment $18 ,000,000
Depreciation of machinery and equipment $5,000,000
Profit per ton $204

T he fixed overhead expenses are cash expenses and the tot al fixed overhead expenses are expected
to remain the same irrespective of any change in the level of production and sales.
The existing equipment is expected to l ast for a further five years, and will have no resale
(scrap/salvage) value   at that point in time.
The new machinery and equipment will cost $100,000,000 and will have an expected life of 5 years.
At the end of which it would be sold for an estimated scrap value of $8,000,000. However,   the
finance manager who is a graduate of Deakin University, knows that he should depreciate the
machinery in such a way that that the time value of the tax benefits relating to depreciation
maximised, while honouring the taxation rules.
If the new machinery and equipment are purchased now, the old machinery and equipment could
be sold for $11,000,000 immediately.
AusSteel has already spent $1,000,000 for the feasibility study of the new project.
If the proposed project goes ahead, AusSteel will have to use   their existing excess warehouse
facilities to store the additional inventories. These excess existing warehouse facilities have been
currently rented to another company at a n annual rent of $1 ,200 ,000.
As the a uthor, the copyright of this   case study (assignment) remains with Samson Ekanayake    Page 4

MAF 203 – Business Finance   Group Assignment   Case Study
T2, 2014    Capital Budgeting –   AusSteel Ltd
The accountant has also prepared the following data to help assess the proposed change.
Selling Price per ton $1,250
Variable expenses –   per ton manufactured and sold   $   900
Fixed overhead expenses
excluding depreciation of machinery and equipment $18,000,000
Depreciation of machinery and equipment $ 20,000,0 00
Profit per ton $280.91

If the new machinery and equipment are installed, the raw material (steel) inventory will have to be
increased by $12 ,000,000.
The new technology involves using more chemicals, which may be harmful to the environment if not
treated properly.
The appropriate, after tax, cost of capital (discount rate) for the project is considered to be 11 %. This
is same as the company’s after tax weighted average cost of capital. Assume that the company is
subject to 30% corporate tax and tha t the tax is paid at end of the same year (i.e. not the following
year).
Also assume, that entire production will be sold within the year and there will be no finished goods
inventory.
The company’s bank is willing to lend the funds required for new machinery and equipment at a 9%
annual interest rate.

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