Capital Budgeting Project of Sunshower
Project Overview
Sunshower is a well-known food manufacturer located in Australia, mainly producing baked snacks and whole grain biscuits. In recent years, with the increase in fitness people and vegetarians, the company has found that the market demand for high-end plant protein healthy snacks has grown rapidly. In order to seize the opportunity in this market segment, the company plans to launch a new product line that is plant-based protein bars.
Purchasing and selling Asset 1
The production of the plant-based protein bars requires acquiring a new food processing machine (Asset 1) that can handle specialized mixing, extrusion, and low-temperature baking processes. Sunshower intends to purchase the new equipment in Year 0 at a cost of AUD 420,000. Although the machine has a 6-year useful lifen for tax purposes, the project will be run for only 5 years, after which the equipment will be sold at AUD 60,000 due to expected technological obsolescence.
Annual revenue of the project
Since the rapid growth of the Australian plant protein snack market, Sunshower expects revenue to grow rapidly in the first two years, reaching AUD 550,000 in Year 1 and AUD 600,000 in Year 2. However, due to increased competition, the company expects sales to decline in Years 3 to 5, reaching AUD 480,000, AUD 400,000 and AUD 360,000.
Annual increased expense and unchanged expense
The raw materials are expected to cost AUD 40,000 in the first year. However, due to the rise of price level and increased production, Sunshower expects the cost of raw materials to increase by 10% each year.
Meanwhile, the annual labor expense remain unchanged at AUD 90,000.
Purchasing and selling Equipment 1
The company already owns a high-capacity mixing unit (Equipment 1) purchased 4 years ago with a loan of AUD 180,000, and AUD 6,000 in annual interest paid over the past four years. The equipment has 3 years of remaining depreciable life, and its current book value is AUD 75,000. Although the company received a purchase offer of AUD 95,000 in Year 0, the company decides to retain and repurpose the equipment for the new project. By the end of the project, Equipment 1 is expected to be sold for AUD 40,000, generating a capital gain.
Change in working capital at the start of the project
To support the increase in production and inventory turnover, AUD 35,000 in additional working capital will be required at the start of the project. This working capital is anticipated to be fully recovered by the end of Year 5.
Investment amount from shareholders with dividend amount
To help finance the expansion, shareholders have committed AUD 150,000 in equity investment at the start of the project. In return, the company will pay dividends of AUD 10,000 annually during the 5 year project term. This arrangement strikes a balance between retaining earnings for operations and rewarding investor confidence.
Financial Metrics
The required return for the project is 7%, which reflects the company’s weighted average cost of capital and the risk profile of launching a new product. Sunshower also maintains a strict payback policy that is any new project must recover its initial investment within 2 years. Considering the corporate tax situation in Australia, the tax rate is 30%,.