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Your paper should include a capital budget analysis, an
interpretation of the analysis and your recommended strategy
for the Deluxe Corporation.
Deluxe Corporation is a large chain of retail stores
operating in the USA. It sells top-of the-
range, expensive clothes to a wealthy clientele throughout
the country. Currently, Deluxe
only operates in the USA. Its current market
capitalization is $760 million and the current
market value of debt is $350 million.
At last month’s management meeting the marketing director
explained that sales volume
had increased slightly in the previous year, largely due to
heavy discounting in most of its
stores. The finance director expressed concern that such a
strategy might damage the
image of the company and reduce profits over the longer
term.
An alternative strategy to increase sales volume has
recently been proposed by the
marketing department. This would involve introducing a new
range of clothing specifically
aimed at the middle-income market. The new range of clothing
would be expected to be
attractive to consumers in Canada and Europe.
Assume your represent the financial management of Deluxe and
have been asked to
evaluate the marketing department’s proposal to introduce a
new range of clothing. An
initial investigation into the potential markets has been
undertaken by a firm of
consultants at a cost of $100,000 but this amount has not
yet been paid. It is intended to
settle the amount due in three months’ time. With the help
of a small multi-department
team of staff you have estimated the following cash flows
for the proposed project:
•
The initial investment required would be $46 million: This
comprises $30 million for
fixed assets and $16 million for net current assets (working
capital).
•
For accounting purposes, fixed assets are depreciated on a
straight line basis over three
(3) years after allowing for a residual value of 10%.
•
The value of net current assets at the end of the evaluation
period can be assumed to be
the same as at the start of the period.
•
Earnings before taxes are forecast to be $14 million in
2016, $17million in 2017 and
$22 million in 2018.
The following information is also relevant:
•
The proposed project is to be evaluated over a three-year
time horizon. The firm uses Net
Present Value and Internal Rate of Return methods to
evaluate projects.
•
Deluxe usually evaluates its investments using an after-tax
discount rate of 8%. The
proposed project is considered to be riskier than average
and so a risk-adjusted rate of
9% will be used for this project.
Managing Financial Resources – BUS 635
Case Paper – Capital Budget Analysis
Case Paper – Online Campus
Page 2
•
Corporate tax is 25%.
•
Ignore inflation.
•
Prepare a Sensitivity Risk Analysis with the following
variables: Earnings Before Taxes,
Project Discount Rate, and Tax Rate. Your margins of
variance are plus/minus 10%, 20%,
30%. Your Sensitivity work should include a graph analysis.
