Principle of Corporate Finance

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5BUS1094 Principles of Corporate Finance

Referral/Deferral Case study 2013-14

Spingo Surfboards plc.

In 1971 Danny and Doris Spingo, enthusiastic surfers, started a small surfboard production business in the South West of England. Their business expanded as surfing became more popular and demand for their hand crafted surfboards increased. From their small beginnings grew the now publicly quoted company of Spingo Surfboards plc.

In recent years the directors, headed by the Chief Executive Officer, Derek, have decided that the business has reached the limit of development in its present form. Future development requires large-scale expansion in order to compete with the cost base of mass produced surfboards.

They have investigated a number of possibilities, deciding eventually to expand their production facilities and establish their own distribution system so that their newly ‘branded’ products can be sold in independent, quality retailers around Great Britain.

 

Any new venture would be expected to achieve a payback period of 5 years, as well as to provide an increase in shareholder wealth. Spingo would need to agree a realistic price for their new venture and its future cash flows in order to determine whether these criteria could be met.

 

They intend their new venture to last for 10 years. The company’s cost of capital is 12%.

There are two options available to Spingo.

The first (Option 1) is the acquisition of a new larger production and distribution facility in the local area at a cost of £15,000,000, payable immediately. This would involve transferring all current production to this new facility. If Spingo decided to proceed with this option the current facility would be sold immediately. They have been given an estimate of £7,750,000 for the sale proceeds. New plant and machinery would need to be purchased at a cost of £9,500,000 before production could begin. This plant and machinery would be sold at the end of the ten year period for an estimated scrap value of £2,500,000.

The second (Option 2) is the expansion of the current production facility to increase production capacity and provide a distribution facility. The building and refurbishment costs for this expansion would amount to £11,000,000, payable immediately. New plant and machinery would need to be purchased at a cost of £5,500,000 before production could begin. This plant and machinery would be sold at the end of the ten year period for an estimated scrap value of £1,000,000.

In order to assess the building and investment costs of the two options, Spingo have already paid professional fees of £20,000. Further professional fees will be incurred at the start of the project, as follows:

 

Option 1: £50,000

Option 2: £35,000

Other costs and revenues relating to Option 1 are as follows:

 

	Yr 1	Yr 2	Yr 3	Yr 4	Yr 5	Yr 6	Yr 7	Yr 8	Yr 9	Yr 10
	£000	£000	£000	£000	£000	£000	£000	£000	£000	£000
Increase in Sales revenue	5000	7570	7000	7500	8000	8500	9000	9500	10000	11000
Increase in Variable costs	1500	1750	2200	2500	2750	2900	3000	3100	3200	3600
Increase in Fixed costs	1500	1500	1500	1500	1500	1500	1500	1500	1500	1500

Other costs and revenues relating to Option 2 are as follows:

 

	Yr 1	Yr 2	Yr 3	Yr 4	Yr 5	Yr 6	Yr 7	Yr 8	Yr 9	Yr 10
	£000	£000	£000	£000	£000	£000	£000	£000	£000	£000
Increase in Sales revenue	5250	5500	7000	7250	8250	9000	9100	9600	10500	11150
Increase in Variable costs	1400	1600	1900	2200	2600	2800	2850	3000	3050	3200
Increase in Fixed costs	2250	2250	2250	2250	2250	2250	2250	2250	2250	2250

 

The two options are mutually exclusive and a decision has to be made as to which to proceed with.

Required:

Produce an INDIVIDUAL written report of no more than 2500 words, evaluating the proposal on behalf of Spingo Surfboards plc and making a firm recommendation on the viability of the project. Your report should cover the following areas:

1. An investment appraisal of the project, using payback, NPV and IRR, evaluating the results and recommending an appropriate course of action, taking into consideration the strengths and weaknesses and the usefulness of each method of investment appraisal used. You should also consider the company’s stated investment criteria.

 

1. With reference to relevant academic sources, a short discussion of any additional non-financial factors to be taken into account when evaluating the project and deciding on the appropriate course of action. State how these might affect the investment decision.

 

1. An alternative method of expanding the company’s business would be to acquire another surfboard manufacturer. Explain the motivations for the acquisition of one company by another and discuss how this could help Spingo achieve their aim of increasing shareholder wealth.

Your work should include relevant research, appropriately sourced and referenced using Harvard format.

Your report should include the following sections:

 

1. Title Page
2. Introduction
3. Results of investment appraisal calculations, in summary form
4. Discussion/Analysis (to be structured according to the headings 1, 2, and 3 above)
5. Overall conclusions and recommendations
6. References
7. Appendices (includes calculations)

Please go to ASU for help if you are unsure about how to write a report or use Harvard referencing or if previous feedback has recommended that you should be referred to ASU.

Please use double line spacing and font size no less than 12.

Submit one electronic copy via StudyNet.

Ensure that you display the word count (not including the bibliography or appendices) on the title page.

Assessment Criteria

You will be assessed on:

 

• Investment appraisal (15%)

o   Correct cash flows used

o   Techniques correctly applied

 

• Evaluation and critical discussion of investment appraisal (35%)

o   Application to the projects and the company, with appropriately justified recommendation.

o   Understanding of theory relating to net present value.

o   Understanding of alternative methods and why they are considered inferior to Net Present Value.

Discussion of additional factors (15%)

o   Recognition of relevant factors to be taken into account

o   Consideration of these factors when making recommendations.

 

• Motives for acquisition (25%)

o   Identification and explanation of the motives for acquisitions.

o   Application of discussion to the case study

 

• Presentation and referencing (10%)

o   Logical presentation in correct format

o   Sentence construction, punctuation, grammar and use of paragraphs

o   Use of relevant academic sources

o   Referencing of information in Harvard format

Your report should be submitted electronically via StudyNet, no later than 11am Monday 16^th June 2014.

Please note that extensions to this deadline will only be given in exceptional cases (illness, bereavement). Requests for extensions must be made at least three days before the deadline date and accompanied by documentary evidence.

 

Late submissions posted on StudyNet within 24 hours of the submission time will receive a 5% penalty, subject to a minimum mark of 40%. Those received after this time but within 7 days of the submission date and time will be capped at 40%. Submissions received more than one week later than the deadline date/time will be awarded a mark of 0%.

The deadline for submission is 11am Monday 16^th June 2014.

 

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