B9AC103: Toys Ltd currently has one product on the market, which has been extremely successful. The company is developing a new advanced model: Corporate Financial Management Assignment, DBS, Ireland

Question 1

Toys Ltd currently has one product on the market, which has been extremely successful

The company is developing a new advanced model – the Matsue.

To date, €220,000 has been spent on developing the product and has also incurred €150,000 in market research costs, although the invoice for these costs has only just been received and will be paid in January. A final decision now needs to be made as to whether it is viable to
manufacture and sell Matsue.

The following revenues and costs have been estimated:

• A new factory, to be used solely for the production of Metsue will need to be built. This will take nearly a year to build and is expected to cost €10·75 million in total, payable in two installments – €5m now in advance of the start of the building work and the remainder will be paid when the building work is completed at the end of the first year.
• Toys Ltd will immediately enter into a one-year contract with a project management company, which will oversee the building of the factory. The cost of €250,000 will be paid when the building is completed. Two production lines will need to be installed in the factory at a further cost of €1.5m. payable in one year’s time.
• Machinery also needs to be built-to-order and is expected to cost €2·5m, payable in one year’s time. It will have a nil value at the end of the project. Depreciation will be charged as soon as production commences (in one year’s time) at 10% per annum on a straight-line basis.
• Maintenance costs for the machinery are estimated at €250,000 per annum starting in year 2.
• Production and Sales as well as related costs will commence in year 2. Sales quantities and prices are expected to be as follows:
  
  It is anticipated that there will be no further sales after these dates.
• Material costs are estimated at €125 per unit.
• Labor costs are estimated at €100 per unit.
• Fixed production overheads relating to the new factory are estimated at €240,000 per annum. Variable production overheads are expected to be €50 per unit.
• Head office costs of €2·5m per annum will be allocated to Metsue when production commences. Of these costs, only €1·7m is incremental.
• The company’s cost of capital is 10%.
• Assume that all cash flows occur at the end of the year, unless stated otherwise.
• All workings should be in €’000.

Question 2

• Describe the difference between systematic and unsystematic risk?
• Two companies DK plc and P plc have the following details.
  Their Beta values market return and risk-free rate are as follows:
  
  The market return is 15%
  The risk-free is 5%
  (i) Calculate the required investor return for both companies.
• The Traditional View and MM (Modigliani & Miller) views on the impact of gearing on WACC (Weighed Average Cost of Capital) have created a lot of debate over the years. Briefly outline the Traditional View and MM, also draw and label the relevant three graphs to illustrate your answer.