Following advice from an agent in Vietnam TNA have an opportunity to purchase a majority interest in a small local firm that manufactures equipment for the food processing and packaging industry. This firm has a factory in a convenient location close to the ports and transport routes and a loyal and hardworking workforce. Unfortunately the factory has outdated equipment and a relatively high cost structure and the firm is increasingly falling behind its competitors. However the Agent’s advice may provide an opportunity for TNA to establish a production facility in the heart of Asia without the problems and lead time involved in developing a Greenfield facility.
Following further enquiries TNA management determine that they could complete the takeover of the Vietnamese company that owns the factory for an investment of $A 10 million, $A 6 million of which would be to purchase 100% of the Vietnamese company and $A 4 million in the form of capital equipment to replace some of the aging factory infrastructure.
If TNA proceed with the takeover they estimate that they can be operational by beginning 2017. They further consider that the existing contracts from the Vietnamese company will provide underpinning revenue equivalent to A$ 200,000 per month at current exchange rates. They are also confident of rapidly gaining additional food processing and packaging business because of the superiority of their new equipment. Their estimates of the value of sales growth per annum in the Vietnamese market are shown in the following table.
YEAR
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| 20% | 30% | 30% | 20% | 10% |
Total costs are assumed to 60% of revenue in the first year and 50% of revenue for subsequent years. The exchange rate at September 18th 2016 is 17160.76Vietnamese Dong per Australian dollar and it is assumed that the inflation rate will be 3% higher in Vietnam than Australia.
Based on the information provided and further research answer the following questions:
Q1. The management of TNA are undecided about their best option for sourcing the $A10 million required for the transaction. Discuss their options for sourcing these funds.
Q2. Carry out a capital budget evaluation of the proposed takeover assuming a 5 year timeframe and an estimated residual value of A$ 200,000 for the capital equipment at the end of the 5 years. Assume that TNA use a weighted average cost of capital of 10% in their financial evaluations. Does the takeover represent a good investment for TNA based on your evaluation? What would be the situation if the investment required was only A$ 7 million?
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