The GFA Company, originally established 16 years ago to make football, is now a leading producer of tennis balls, baseba
Posted: Sun Jun 05, 2022 10:04 am
The GFA Company, originally established 16 years ago to make
football, is now a leading producer of tennis
balls, baseballs, footballs, and golf balls. Nine years ago, the
company introduced “High Flite,” its first line of
high-performance golf balls. GFA management has sought
opportunities in whatever businesses seem to have
some potential for cash flow. Recently Mr. Dawadawa, vice
president of the GFA Company, identified another
segment of the sports ball market that looked promising and that
he felt was not adequately served by larger
manufacturers.
As a result, the GFA Company investigated the marketing
potential of brightly coloured bowling balls. GFA
sent a questionnaire to consumers in three markets: Accra,
Kumasi, and Koforidua. The results of the three
questionnaires were much better than expected and supported the
conclusion that the brightly coloured bowling
balls could achieve a 10 to 15 percent share of the market. Of
course, some people at GFA complained about
the cost of test marketing, which was GH¢ 250,000. Also, the
feasibility test carried out by analysts to assess
the viability of the project cost GH¢ 100,000. In any case, the
GFA Company is now considering investing in a
machine to produce bowling balls. The bowling balls would be
manufactured in a building owned by the firm
and located near Madina. This vacant building and the land can
be sold for GH¢ 150,000 after taxes.
Working with his staff, Dawadawa is preparing an analysis of the
proposed new product. He summarizes his
assumptions as follows: The cost of the bowling ball machine is
GH¢100,000 and it is expected to last five
years. At the end of five years, the machine will be sold at a
price estimated to be GH¢ 30,000. The machine is
depreciated on straight-line basis. The company is exempt from
capital gains tax. Production by year during the
five-year life of the machine is expected to be as follows:
5,000 units, 8,000 units, 12,000 units, 10,000 units,
and 6,000 units. The price of bowling balls in the first year
will be GH¢20. The bowling ball market is highly
competitive, so Dawadawa believes that the price of bowling
balls will increase at only 2 percent per year, as
compared to the anticipated general inflation rate of 5
percent.
Conversely, the plastic used to produce bowling balls is rapidly
becoming more expensive. Because of this,
production cash outflows are expected to grow at 10 percent per
year. First-year production costs will be GH¢10
per unit. Also, ‘Soft Flite’ a substitute product, is expected
to have a drop in its sales by 1000 units per annum.
The selling price per unit of existing products is GH¢5 while
the variable cost is GH¢ 4. Dawadawa has
determined, based on GFA’s taxable income, that the appropriate
incremental corporate tax rate in the bowling
ball project is 34 percent.
Like any other manufacturing firm, GFA finds that it must
maintain an investment in working capital.
Management determines that initial investment (at Year 0) in net
working capital of GH¢10,000 is required.
Subsequently, net working capital at the end of each year will
be equal to 10 percent of sales for that year. In
the final year of the project, net working capital will decline
to zero as the project is wound down. In other
words, the investment in working capital is to be completely
recovered by the end of the project’s life.
GFA will finance the total investment required for the
production of the balls (including working capital
investment) by issuing 100,000 new common stocks at GH¢ 2 per
share from its existing shareholders. A total
of GH¢ 200,000 is expected to be raised from the rights issue.
It expects to finance the remaining from a bank
loan from GDB at a rate of 12%. Mr. Dawadawa has estimated the
beta of the project to be 2.5 and the average
return for stocks traded on the Ghana Stock Exchange to be 10%
while the rate on Government of Ghana traded
Treasury bills is 5%.
DC: ACD01-F004DC: ACD01-F004
Required:
a. Evaluate the project using NPV and advise the Management
of GFA whether or not it should introduce the
bowling balls (10 marks)
b. Discuss three (3) qualitative factors that the
Management of GFA might have to consider before making a
decision. (3 marks)
c. What does the beta of the project represent and how will
higher project betas affect your decision?
(2 marks)
d. Compare and contrast the beta of the project and explain
how it will affect the return on investment of the
project. (3 marks)
e. How do you expect the financing of the project to be
treated in the project cash flow estimation?
football, is now a leading producer of tennis
balls, baseballs, footballs, and golf balls. Nine years ago, the
company introduced “High Flite,” its first line of
high-performance golf balls. GFA management has sought
opportunities in whatever businesses seem to have
some potential for cash flow. Recently Mr. Dawadawa, vice
president of the GFA Company, identified another
segment of the sports ball market that looked promising and that
he felt was not adequately served by larger
manufacturers.
As a result, the GFA Company investigated the marketing
potential of brightly coloured bowling balls. GFA
sent a questionnaire to consumers in three markets: Accra,
Kumasi, and Koforidua. The results of the three
questionnaires were much better than expected and supported the
conclusion that the brightly coloured bowling
balls could achieve a 10 to 15 percent share of the market. Of
course, some people at GFA complained about
the cost of test marketing, which was GH¢ 250,000. Also, the
feasibility test carried out by analysts to assess
the viability of the project cost GH¢ 100,000. In any case, the
GFA Company is now considering investing in a
machine to produce bowling balls. The bowling balls would be
manufactured in a building owned by the firm
and located near Madina. This vacant building and the land can
be sold for GH¢ 150,000 after taxes.
Working with his staff, Dawadawa is preparing an analysis of the
proposed new product. He summarizes his
assumptions as follows: The cost of the bowling ball machine is
GH¢100,000 and it is expected to last five
years. At the end of five years, the machine will be sold at a
price estimated to be GH¢ 30,000. The machine is
depreciated on straight-line basis. The company is exempt from
capital gains tax. Production by year during the
five-year life of the machine is expected to be as follows:
5,000 units, 8,000 units, 12,000 units, 10,000 units,
and 6,000 units. The price of bowling balls in the first year
will be GH¢20. The bowling ball market is highly
competitive, so Dawadawa believes that the price of bowling
balls will increase at only 2 percent per year, as
compared to the anticipated general inflation rate of 5
percent.
Conversely, the plastic used to produce bowling balls is rapidly
becoming more expensive. Because of this,
production cash outflows are expected to grow at 10 percent per
year. First-year production costs will be GH¢10
per unit. Also, ‘Soft Flite’ a substitute product, is expected
to have a drop in its sales by 1000 units per annum.
The selling price per unit of existing products is GH¢5 while
the variable cost is GH¢ 4. Dawadawa has
determined, based on GFA’s taxable income, that the appropriate
incremental corporate tax rate in the bowling
ball project is 34 percent.
Like any other manufacturing firm, GFA finds that it must
maintain an investment in working capital.
Management determines that initial investment (at Year 0) in net
working capital of GH¢10,000 is required.
Subsequently, net working capital at the end of each year will
be equal to 10 percent of sales for that year. In
the final year of the project, net working capital will decline
to zero as the project is wound down. In other
words, the investment in working capital is to be completely
recovered by the end of the project’s life.
GFA will finance the total investment required for the
production of the balls (including working capital
investment) by issuing 100,000 new common stocks at GH¢ 2 per
share from its existing shareholders. A total
of GH¢ 200,000 is expected to be raised from the rights issue.
It expects to finance the remaining from a bank
loan from GDB at a rate of 12%. Mr. Dawadawa has estimated the
beta of the project to be 2.5 and the average
return for stocks traded on the Ghana Stock Exchange to be 10%
while the rate on Government of Ghana traded
Treasury bills is 5%.
DC: ACD01-F004DC: ACD01-F004
Required:
a. Evaluate the project using NPV and advise the Management
of GFA whether or not it should introduce the
bowling balls (10 marks)
b. Discuss three (3) qualitative factors that the
Management of GFA might have to consider before making a
decision. (3 marks)
c. What does the beta of the project represent and how will
higher project betas affect your decision?
(2 marks)
d. Compare and contrast the beta of the project and explain
how it will affect the return on investment of the
project. (3 marks)
e. How do you expect the financing of the project to be
treated in the project cash flow estimation?