HIAP SENG TYRE SDN BHD Hiap Seng Tyre Sdn. Bhd. is a Malaysian tire and tube man
ID: 2657380 • Letter: H
Question
HIAP SENG TYRE SDN BHD Hiap Seng Tyre Sdn. Bhd. is a Malaysian tire and tube manufacturer with its factory located in Shah Alam. Hiap Seng's products obtained ISO-9001 certification. Assume that Hiap Seng has recently developed a new model of tire (called Super Tire) after extensive research and development and that the research and development costs have totaled about RM10 million. A RM5 million market testing expenses has also spent and proved that there is a significant market for the new model. The new model will be put into the market this year and is expected to stay in the market for four years As a financial analyst of Hiap Seng, you have to evaluate and provide recommendation on whether to go ahead with the investment. Except for the initial investment that will occur immediately, all cash flows will occur at year end. To make the new model, Hiap Seng has to initially invest RM140 million in production equipment. The equipment can be sold for RM54 million at the end of four years. Hiap Seng can sell the new model to two distinct markets 1. Original manufacturer market (such as Proton, Perodua, etc)-this market consists primarily of the large automobile companies that buy tires for new cars. The new model is expected tosel for RM38 per tire, and the variable cost of each tire is RM22. 2. Replacement market -this market consists of all tires purchased after the automobile has left the factory. The new model in this market is expected to sell for RM59 per tire, and the variable cost of each tire is RM22 which is the same as that in the original manufacturer market The project will incur RM26 million in marketing and general administrative costs the first year, and this cost is expected to increase at the inflation rate in subsequent years. Hiap Seng also intends to raise the selling price of the new tire at the inflation rate. The annual inflation rate is expected to remain constant throughout the project (based on Malaysian inflation rate as at January 2018) Variable costs are expected to increase at 1 percent above the inflation rate (nominal rate)Explanation / Answer
INITIALCASH FLOW Production equipment 140,000,000 Initial Working Capital 10,000,000 A Total Initial Cash Flow 150,000,000 Annual Cash Flows: (Based on January 2018 MalayasianInflationRate) Inflation Rate=2.7%= 0.027 Rate of increase of selling price 0.027 Rate of increase Variable Costs 0.037 N Year 1 2 3 4 B Sales Price in OEM market 38.00 39.03 40.08 41.16 C Sales Price in Replacement market 59.00 60.59 62.23 63.91 D Variable cost per tire 22.00 22.81 23.66 24.53 E=B-D Contribution margin for OEM market 16.00 16.21 16.42 16.63 F=C-D Contribution margin for Replacement market 37.00 37.78 38.57 39.38 G Annual production of new cars 5,600,000 5,740,000 5,883,500 6,030,588 H=G*0.11*4 Quantity of sales in OEM market 2,464,000 2,525,600 2,588,740 2,653,459 I Demand of Tires in replacement market 14,000,000 14,280,000 14,565,600 14,856,912 J=0.08*I Quantity of sales in Replacement market 1,120,000 1,142,400 1,165,248 1,188,553 K=E*H Contribution from OEM Market 39,424,000.00 40,945,027.20 42,511,211.36 44,122,731.08 L=F*J Contribution from Replacement Market 41,440,000 43,158,730 44,944,656 46,800,136 M=K+L Total Contribution 80,864,000 84,103,757 87,455,867 90,922,867 P Marketing and General administration cost (26,000,000) (26,702,000) (27,422,954) (28,163,374) Q=M+P Annual before tax cash Flow 54,864,000 57,401,757 60,032,913 62,759,493 Current Malayasian Corporate Tax rate=24% R=Q*(1-0.24) Annual after tax cash flow 41,696,640 43,625,335 45,625,014 47,697,215 Depreciation Tax shield T=(140000000-54000000)/4 Annual Depreciation 21,500,000 21,500,000 21,500,000 21,500,000 U=T*0.24 Depreciation Tax Shield 5,160,000 5,160,000 5,160,000 5,160,000 V=B*H+C*J Annual Sales 159,712,000 167,785,509 176,268,158 185,180,733 W=0.15*V Working Capital needed 23,956,800 25,167,826 26,440,224 27,777,110 X Cash Flow due to working capital increase (13,956,800) (1,211,026) (1,272,397) (1,336,886) Y=R+U+X Net Annual After Tax Cash Flow 32,899,840 47,574,309 49,512,617 51,520,328 Z Terminal Cash Flow 81,777,110 *Clculation shown below) TCF=Y+Z Total Cash Flow 32,899,840 47,574,309 49,512,617 133,297,438 SUM Requiredb return=16.5%=0.165 PV=TCF/(1.165^N) Present Value of Cash Flow 28,240,206 35,052,632 31,313,968 72,363,256 166,970,063 NPV Net Present Value 16,970,063 (166970063-150000000) PI Profitability Index 1.11 (166970063/150000000) CALCULATION OF TERMINALCASH FLOW* Salvage Value 54,000,000 Working Capital Release 27,777,110 Net terminal caah Flow 81,777,110 * Year 0 1 2 3 4 Net Cash Flow (150,000,000) 32,899,840 47,574,309 49,512,617 133,297,438 Cumulative Cash Flow (150,000,000) (117,100,160) (69,525,851) (20,013,234) 113,284,204 Present Value of Cash Flow (150,000,000) 28,240,206 35,052,632 31,313,968 72,363,256 Cumulative Present value of Cash Flow (150,000,000) (121,759,794) (86,707,162) (55,393,194) 16,970,063 IRR Internal rate of Return 20.95% (Using IRR function of excel over Net Cash Flow) Pay Back Period in Years 3.15 (3+(20013/133297438) Based on period when Cumulative cash flow=NIL Discounted Payback period in years 3.77 (3+(55393194/72363256) Based on period when Cumulativepresent value of cash flow=NIL
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