NRW Holdings Limited (“NRW”) is a company listed on the Australian Securities Exchange (ASX). According to the following
Posted: Thu Apr 28, 2022 1:27 pm
NRW Holdings Limited (“NRW”) is a company listed on the
Australian Securities Exchange (ASX). According to the following
ASX announcement (hereafter, Announcement) made by NRW: 17/02/2022
9:35 am NRW Half Year Results Presentation the coal market is very
strong. NRW is keen to take advantage of this strength and is
investigating a proposal to replace one of their outdated
inefficient mining trucks with a new CAT 793F truck. The new truck
offers a larger carrying capacity and lower maintenance costs
compared to the existing truck, and opens up more “Load & haul”
contracting opportunities . Furthermore, as part of NRW’s
environmental initiatives, the new truck has a reduced fuel
consumption. However, the cost of a new CAT 793F is $4.7 million
and NRW’s management accountant is concerned that the new truck’s
profitability won’t justify the cost. Therefore, the accountant has
approached the Chief Financial Officer (CFO) to express concerns.
The CFO carefully and slowly explains the many reasons that
profitability is not a good measure of financial success, and
stresses that the appropriate action is to conduct a rigorous
cost-benefit analysis to ensure that replacing the truck will add
shareholder wealth.
2. Last month, NRW paid for a study by a civil engineering
consultant at a cost of $75,000 and the study concluded that the
large and growing infrastructure market will generate sufficient
demand for a larger truck. Today, NRW must decide if they will
proceed with the investment in the new truck, and the simultaneous
sale of their existing truck.
3. If NRW purchase the new truck they must pay a third party to
transport the truck to NRW’s main mining facility at Boggabri at a
cost of $26,000.
4. To operate the new truck requires a wide-ranging operator
training programme. Included in the truck’s purchase price is
sufficient initial training to operate the truck for one year.
Then, starting in 2023, the operator must receive additional
training every second year. The training would normally be
performed at NRW’s Operator Training Centre (OTC). However, because
the OTC is at capacity the training must occur at an external
organisation for the foreseeable future at a cost of $45,000. If
the OTC did have spare capacity then NRW could earn income by
training operators from external organisations.
5. According to the consultant, the new truck could easily be
operated for twenty years. However, NRW will operate the truck for
ten years only. The existing truck can be sold for $440,000 today.
If NRW do not purchase the new truck they will continue to operate
the existing truck for a further ten years. The existing truck was
purchased seven years ago for $2.9 million and is being depreciated
over its ten-year tax life at the time of purchase.
6. Some NRW Board members suggest that as the new truck is
analysed over a ten-year time period NRW must recover all the costs
they have incurred to date. They recommend the $75,000 fee paid to
the civil engineering consultant be included as a cash outflow in
2022.
7. NRW will borrow $2 million using a fully amortised ten-year
loan at an interest rate of 5% per annum to partly finance the new
truck. The loan requires annual interest payments of $259,009,
starting in one year’s time.
8. Today, inventory will need to increase by $140,000 to
$640,000, accounts receivable will increase to $750,000 from the
current figure of $660,000, and current liabilities (in the form of
short-term debt) will increase to a total of $800,000 compared to
the current figure of $450,000. Accounts payable will remain at the
current $433,000 figure.
9. The storage shed that NRW constructed in 2020 at a cost of
$675,000 will be retained whether NRW purchases the new truck or
not. This shed is being depreciated over its 20-year life assuming
a salvage value of zero. The management group suggest the shed’s
annual depreciation expense of $33,750 be included in the financial
analysis of the new truck.
10. At the moment, the existing truck generates annual cash
sales of $1,700,000. This sales figure is predicted to remain
constant for each of the next ten years. The new truck is predicted
to generate cash sales of $2.7 million in 2023 and it is
anticipated that this sales figure will increase by 4% per annum
for the foreseeable future.
11. The CFO has gathered some information regarding current and
expected operating costs. At the moment, fixed costs are $400,000
per annum. With the purchase of the new truck fixed costs would
rise to $500,000 in year one and this figure will continue to
increase by 2% p.a. Wages expense is currently $900,000 each year
and is predicted to increase to $1.4 million with the introduction
of the new truck. The CFO clarifies the importance of incremental
cash flow items when performing a financial analysis.
12. The improved fuel economy of the new truck will allow NRW to
reduce its current annual fuel expenditure by $40,000 compared to
the existing truck. The existing truck was relatively fuel
inefficient and used, on average, 290,000 litres of diesel fuel
each year. The CFO assumes the cost of diesel fuel remains constant
for the next ten years at $1.85 per litre.
13. The current annual maintenance cost of the existing truck is
$63,000. The new truck will require no maintenance in the first two
years of its life because it is covered by a manufacturer’s
two-year warranty. However, after the warranty expires in year two
the annual maintenance expense will be $87,000.
14. NRW recently updated its expectation for full-year (FY22)
EBITDA by $5 million to $155 million.
15. According to the Australian Taxation Office (ATO) the new
truck has a twenty-five year life for taxation purposes, and
transportation is a tax-deductible business expense.
16. It costs $175,000 a year to operate NRW’s Boggabri corporate
office. With careful management NRW believes they will not require
any additional personnel in the Boggabri office if they purchase
the new truck. In any case, the operating expenses are assumed to
increase by 3% p.a.
17. The accountant affirms that expenses incurred by NRW in
generating revenue are tax deductible in the year the expense is
incurred.
18. The civil engineer’s report estimates that the new truck
will have a market value of $3 million in ten years’ time. The
existing truck can be sold for $440,000 today. NRW will use these
sale proceeds to distribute a special $440,000 dividend to its
shareholders today. The consultant advises that in ten years’ time
the existing truck would be worthless.
19. The company tax rate is 30% and the required rate of return
is 12%. REQUIREMENTS Your team must answer the following
questions.
All answers must be entered into the preformatted EXCEL
spreadsheet available on Canvas.
Questions 1 to 4 require information relating to the capital
budgeting decision to replace the old mining truck.
Questions 5, 6 and 7 require you to provide some additional
information and calculations about NRW.
Capital Budgeting Information (15 Marks)
Present an itemised breakdown (and the total) for each of the
following:
1. The cash flows at the start.
2. The cash flows over the life.
3. The cash flows at the end.
4. What is the NPV of the truck replacement decision, and your
recommendation? Additional Information (5 Marks)
5. The Announcement refers to NRW’s “Very low level of
gearing”.
a) How is this figure calculated?
b) What is an advantage of a low level of gearing?
6. Other than reduced fuel consumption, state one other NRW
environmental initiative.
7. The Announcement states that “NRW is in full compliance with
its continuous disclosure obligations”
a) Who are these obligations to? b) Why are these obligations
important?
Australian Securities Exchange (ASX). According to the following
ASX announcement (hereafter, Announcement) made by NRW: 17/02/2022
9:35 am NRW Half Year Results Presentation the coal market is very
strong. NRW is keen to take advantage of this strength and is
investigating a proposal to replace one of their outdated
inefficient mining trucks with a new CAT 793F truck. The new truck
offers a larger carrying capacity and lower maintenance costs
compared to the existing truck, and opens up more “Load & haul”
contracting opportunities . Furthermore, as part of NRW’s
environmental initiatives, the new truck has a reduced fuel
consumption. However, the cost of a new CAT 793F is $4.7 million
and NRW’s management accountant is concerned that the new truck’s
profitability won’t justify the cost. Therefore, the accountant has
approached the Chief Financial Officer (CFO) to express concerns.
The CFO carefully and slowly explains the many reasons that
profitability is not a good measure of financial success, and
stresses that the appropriate action is to conduct a rigorous
cost-benefit analysis to ensure that replacing the truck will add
shareholder wealth.
2. Last month, NRW paid for a study by a civil engineering
consultant at a cost of $75,000 and the study concluded that the
large and growing infrastructure market will generate sufficient
demand for a larger truck. Today, NRW must decide if they will
proceed with the investment in the new truck, and the simultaneous
sale of their existing truck.
3. If NRW purchase the new truck they must pay a third party to
transport the truck to NRW’s main mining facility at Boggabri at a
cost of $26,000.
4. To operate the new truck requires a wide-ranging operator
training programme. Included in the truck’s purchase price is
sufficient initial training to operate the truck for one year.
Then, starting in 2023, the operator must receive additional
training every second year. The training would normally be
performed at NRW’s Operator Training Centre (OTC). However, because
the OTC is at capacity the training must occur at an external
organisation for the foreseeable future at a cost of $45,000. If
the OTC did have spare capacity then NRW could earn income by
training operators from external organisations.
5. According to the consultant, the new truck could easily be
operated for twenty years. However, NRW will operate the truck for
ten years only. The existing truck can be sold for $440,000 today.
If NRW do not purchase the new truck they will continue to operate
the existing truck for a further ten years. The existing truck was
purchased seven years ago for $2.9 million and is being depreciated
over its ten-year tax life at the time of purchase.
6. Some NRW Board members suggest that as the new truck is
analysed over a ten-year time period NRW must recover all the costs
they have incurred to date. They recommend the $75,000 fee paid to
the civil engineering consultant be included as a cash outflow in
2022.
7. NRW will borrow $2 million using a fully amortised ten-year
loan at an interest rate of 5% per annum to partly finance the new
truck. The loan requires annual interest payments of $259,009,
starting in one year’s time.
8. Today, inventory will need to increase by $140,000 to
$640,000, accounts receivable will increase to $750,000 from the
current figure of $660,000, and current liabilities (in the form of
short-term debt) will increase to a total of $800,000 compared to
the current figure of $450,000. Accounts payable will remain at the
current $433,000 figure.
9. The storage shed that NRW constructed in 2020 at a cost of
$675,000 will be retained whether NRW purchases the new truck or
not. This shed is being depreciated over its 20-year life assuming
a salvage value of zero. The management group suggest the shed’s
annual depreciation expense of $33,750 be included in the financial
analysis of the new truck.
10. At the moment, the existing truck generates annual cash
sales of $1,700,000. This sales figure is predicted to remain
constant for each of the next ten years. The new truck is predicted
to generate cash sales of $2.7 million in 2023 and it is
anticipated that this sales figure will increase by 4% per annum
for the foreseeable future.
11. The CFO has gathered some information regarding current and
expected operating costs. At the moment, fixed costs are $400,000
per annum. With the purchase of the new truck fixed costs would
rise to $500,000 in year one and this figure will continue to
increase by 2% p.a. Wages expense is currently $900,000 each year
and is predicted to increase to $1.4 million with the introduction
of the new truck. The CFO clarifies the importance of incremental
cash flow items when performing a financial analysis.
12. The improved fuel economy of the new truck will allow NRW to
reduce its current annual fuel expenditure by $40,000 compared to
the existing truck. The existing truck was relatively fuel
inefficient and used, on average, 290,000 litres of diesel fuel
each year. The CFO assumes the cost of diesel fuel remains constant
for the next ten years at $1.85 per litre.
13. The current annual maintenance cost of the existing truck is
$63,000. The new truck will require no maintenance in the first two
years of its life because it is covered by a manufacturer’s
two-year warranty. However, after the warranty expires in year two
the annual maintenance expense will be $87,000.
14. NRW recently updated its expectation for full-year (FY22)
EBITDA by $5 million to $155 million.
15. According to the Australian Taxation Office (ATO) the new
truck has a twenty-five year life for taxation purposes, and
transportation is a tax-deductible business expense.
16. It costs $175,000 a year to operate NRW’s Boggabri corporate
office. With careful management NRW believes they will not require
any additional personnel in the Boggabri office if they purchase
the new truck. In any case, the operating expenses are assumed to
increase by 3% p.a.
17. The accountant affirms that expenses incurred by NRW in
generating revenue are tax deductible in the year the expense is
incurred.
18. The civil engineer’s report estimates that the new truck
will have a market value of $3 million in ten years’ time. The
existing truck can be sold for $440,000 today. NRW will use these
sale proceeds to distribute a special $440,000 dividend to its
shareholders today. The consultant advises that in ten years’ time
the existing truck would be worthless.
19. The company tax rate is 30% and the required rate of return
is 12%. REQUIREMENTS Your team must answer the following
questions.
All answers must be entered into the preformatted EXCEL
spreadsheet available on Canvas.
Questions 1 to 4 require information relating to the capital
budgeting decision to replace the old mining truck.
Questions 5, 6 and 7 require you to provide some additional
information and calculations about NRW.
Capital Budgeting Information (15 Marks)
Present an itemised breakdown (and the total) for each of the
following:
1. The cash flows at the start.
2. The cash flows over the life.
3. The cash flows at the end.
4. What is the NPV of the truck replacement decision, and your
recommendation? Additional Information (5 Marks)
5. The Announcement refers to NRW’s “Very low level of
gearing”.
a) How is this figure calculated?
b) What is an advantage of a low level of gearing?
6. Other than reduced fuel consumption, state one other NRW
environmental initiative.
7. The Announcement states that “NRW is in full compliance with
its continuous disclosure obligations”
a) Who are these obligations to? b) Why are these obligations
important?