XYZ Ltd is a manufacturer and distributor of agricultural equipment. XYZ produces milking machines and supplies as well as being the sole Australian distributor of machinery from the US- based company FarmGo Ltd.
The CEO of XYZ has been negotiating for some time with a German company that produces new technology equipment that assists farmers with climatic information such as recording and predicting rainfall patterns, temperature readings and historical livestock sale values. In order to become the Australian distributor of this new technology, a $300,000,000 payment would be required to secure the rights. A further $20,000 would need to be spent to secure trade names in Australia. It is expected that the unit price of the sale of the technology to farmers would be $50,000 with the cost being $38,000 per unit. The following unit sales are anticipated:
Year 1 6,000
Year 2 12,000
Year 3 12,000
Year 4 10,000
Year 5 6,000
The company's Marketing Manager anticipates that a $40,000 marketing campaign would need to be undertaken in the first year in order to create the expected demand. This is based on a $12,000 study already completed by an external marketing agency. XYZ's Finance Manager has determined that thlicence will lead to an increase in Net Working Capital of $60,000. An ATO ruling has been gained to allow the write off of the rights and trade name payments over the 5 years for tax purposes. The cost of external assistance in gaining this ruling was $7,000. At present the company pays tax at a rate of 30 cents per dollar.
The cost of capital for the company is 12%.
Part 1
(a) Calculate, showing all workings:
- Net Present Value
- Discounted and Undiscounted Payback Period
- Profitability Index
- Internal Rate of Return to 2 decimal places
(b) Write a one page memo to the CEO of XYZ advising him as to whether the company should proceed with gaining the right, giving reasons for your decision.
(c) The original contract with FarmGo Ltd includes a clause requiring XYZ to make a one-off payment of $70,000 to the US company if they gain any other exclusive distribution rights. Also an ongoing payment of $10,000 is required for the life of the licence.
Part 2
(a) What is the effect on the NPV for the project if (Treat each of the following situations independently): a. Sale of rides figure decreased by 10% (from the initial estimates) between year 3 and 5
b. The tax rate changed from 30% to 25%
c. The board is not convinced with your study and would like to order another independent study. The study is estimated to cost $7500.