Financial Management

Financial Management Assignment

2003/2004

Semester 2

Quinn Limited is a private family owned company, established in the late
1960's by Tom Quinn, who is the current managing director and 60%
shareholder. Since incorporation the company has manufactured plastic
trays and cups used on aeroplanes for passenger meals. Until the mid
1990's this was its only product, however since then other similar
plastic products have been added to the portfolio, including clear
plastic bottles for soft drinks. Until recently this was a very small
part of the total operation, however, under the guidance and drive of
Jonathan Quinn (the son of Tom Quinn and a 20% shareholder), the company
has developed bio- degradable plastic soft drinks bottles. As a result
of this significant innovation, Quinn Limited has been approached by a
major world-wide soft drinks manufacturer to supply these bottles under
a 15-year contract.

The Contract:

The contract is for 10,000 boxes of bottles for each of the first three
years, 12,000 for each of the next nine years and 15,000 for each of the
last three years. The contract-selling price of each box will be Ј550
in the first year with a 3% increase each year.

Expansion Plans:

\

In order to meet this contract Jonathan Quinn is considering two
mutually exclusive options:

2,

To set up a new factory specifically for the production of the new bio-
degradable bottles which will be sold after fifteen years.

To expand the existing factory. This will however result in a reduction
in the production of existing product ranges.

Option 1

Preliminary cost estimates have been drawn up concerning the building of
the new factory, which will be sited in Southeast Wales. These are as
follows:

Ј Ј Ј Ј Ј

Land 1 000 000

Factory building 8 000 000

Plant and Equipment 9 000 000

Office Fixtures and fittings 500 000

18 500 000

Production costs in the new factory will be Ј300 per box in the first
year, rising by 2% per annum thereafter. Additional annual cash flows
are Ј150,000 for administration and Ј50,000 for distribution costs
(each anticipated to rise at 4% per annum). Depreciation is expected to
be Ј750,000 per annum.

0

At the end of the contract it is anticipated that the factory could be
sold for Ј20 million (after tax).

Option 2:

Expansion of the current manufacturing facility will require expenditure
of Ј6 million on new plant and equipment. Production costs will be
Ј325 per box (rising by 2 % per annum). Due to the expansion additional
administration costs of Ј15,000 per annum (rising by 3% per annum) will
be borne.

As a direct result of the expansion at the existing factory, Quinn
Limited will no longer be able to manufacture and sell some of its
existing range. Net revenues are expected to fall by Ј1.5 million per
annum (rising by 2% per annum) as a result of this.

Other relevant information:

The corporate tax rate can be assumed to remain at 30% throughout the
life of the project and taxation is paid one year in arrears. Capital
allowances are available on the plant and machinery expenditure on a
straight-linebasis over 10 years. '\

Quinn Limited's current cost of capital is 10%.

You can assume that other than the initial expenditure, all cash flows
arise at the end of the year to which they relate.

Required:

Prepare a report to the directors of Quinn Limited concerning the
proposed expansion. Your report should include the following:

a) An evaluation of whether option 1 option 2 should be undertaken.
Should include:

This

11.

Calculation and comparison of the net present value for each option.

An analysis of other matters (i.e.: other than the net present value) to
be considered in the decision process.

b) An evaluation of appropriate sources of finance that could be used to
fund your chosen option.

You report should be word processed and of not more than 2,500 words.
Detailed net present value calculations should be included as an
appendix.