CASE STUDY Huonville Fisheries Company Ltd (HFC) is a company in aquacultural industry specialised in farming of aquatic
Posted: Sun May 08, 2022 10:21 am
CASE STUDY
Huonville Fisheries Company Ltd (HFC) is a company in aquacultural
industry specialised in farming of
aquatic organisms. HFC is considering opening a new farm near Huon
Valley. This project would involve
the purchase of 10 hectares land at a price of $1,000,000 (Note
that: The land is not subject to depreciation
for accounting and tax purposes). In addition to that, the company
will need to purchase eight new
equipment which cost $100,000 each. These equipments are expected
to be in use for 5 years and after that,
they will be scrapped without any residual value. Each year, each
of these equipment will incur $8,500
maintenance cost. It is assumed that the farm will commence its
operations at the beginning of the next
financial year: 1 July 2022.
Before starting this new operation, HFC will need to redevelop and
renovate the warehouse at the farm.
HFC paid $10,000 for consultation fee and $6,000 for legal fee to
develop a building plan for the
warehouse. The building is expected to cost $200,000. Assume that
HFC is not able to claim any annual tax
deduction for the capital expenditure to the renovation of the
building until the business is sold.
To commence the farm operation, HFC will also need to invest
$50,000 in net working capital. This
amount will change annually and has to be maintained at 5% of sales
throughout the life of the project.
Investment in NWC will be recovered in full by the end of the
project.
Revenue projections from the farm for the next five years are as
follows:
Year 1 Year 2 Year 3 Year 4 Year 5
Beginning 1/7/2022 1/7/2023 1/7/2024 1/7/2025 1/7/2026
Ending 30/6/2023 30/6/2024 30/6/2025 30/6/2026 30/6/2027
Production quantity (tons) 120 140 170 185 185
Price (per tons) $9,100 $9,050 $9,100 $9,145 $9,195
Operating variable costs associated with the new business including
material costs and labour costs.
Estimated material costs per tons in year 1 is $2,000 and this cost
will increase by 10% every year. The
farm will require about 10 workers working for 8 hours a day, 200
days per year. The pay rate is flat at
$27.5/ hour including superannuation. Annual operating fixed costs
associated with production (excluding
depreciation) are $100,000. Existing administrative costs are
$600,000 per annum. As a result of the new
operation, these administrative costs will increase by 30%. The
company is subject to a tax rate of 30% on
its profits.
Meanwhile, HFC is currently financed by 60% of equity and 40% of
debt. Company’s bond is traded at a
price of $980. The bond has 10-year term, 8% coupon rate paid
semi-annually and face value of $1,000. In
Semester 1, 2020
addition, company’s equity has a beta of 1.2 while the risk-free
rate in the market is 3% and market
portfolio return is estimated to be 12%.
Catherine, the company CFO would like you to help her examine the
viability of the project for the next
five years, taking into account the projections of sales and
operations costs prepared by company’s
accountants.
Your tasks:
Based on the information in the case study, Catherine has asked you
to write a report to HFC’s
management advising them as to the best course of action regarding
this project. Your report should
address the following specific questions asked by HFC’s
management:
1. Discuss which costs are relevant for the evaluation of this
project and which costs are not. Your
discussion should be justified by a valid argument and supported by
references to appropriate
sources
2. Determine the initial investment cash flows, termination cash
flows and estimate all cash flows
associated with the project over 5 years. It is assumed that where
relevant, capital expenditures are
expended throughout the year, while cash flows relating to revenue
and operating costs occur at the
end of the year. You will need to broadly describe the method used
for determining those cash
flows.
3. Calculate the project’s payback period. Ignore the time value of
money for this calculation. Briefly
comment on your results.
4. Estimate the Net present value (NPV) and internal rate of return
(IRR) of the project, assuming that
the initial investment is funded by both debt and equity capital
with the proportion of debt and
equity similar to the current capital structure. Assume further
that the business could be sold at the
end of the five years for $1.5 million. This figure includes the
value of the equipment, premises, and
capital gain from the business. Briefly comment on your results and
make appropriate remarks on
the assumptions made for these calculations if necessary.
5. Using sensitivity analysis, recalculate NPV in Q4 using the
scenario of a decrease in project sales
by 10% annually. Briefly comment on the results.
6. Using sensitivity analysis, recalculate NPV in Q4 if the project
is funded entirely by equity (retained
earnings and new share issuance). Briefly comment on the
results
7. Produce an estimate of change in cost of equity (and discount
rate of the project) and the estimated
cash flows of the project given the current situation of COVID-19
in Australia. How would the
NPV of the project change? What is your recommendation to protect
the project against adverse
impact of the pandemic?
Semester 1, 2020
8. In view of your answer to Point 4 to point 7 above, advise
HFC’s management as to whether they
should go ahead with the investment project. In your
recommendations, you may wish to suggest
possible refinements in the method used for evaluating this
project.
Huonville Fisheries Company Ltd (HFC) is a company in aquacultural
industry specialised in farming of
aquatic organisms. HFC is considering opening a new farm near Huon
Valley. This project would involve
the purchase of 10 hectares land at a price of $1,000,000 (Note
that: The land is not subject to depreciation
for accounting and tax purposes). In addition to that, the company
will need to purchase eight new
equipment which cost $100,000 each. These equipments are expected
to be in use for 5 years and after that,
they will be scrapped without any residual value. Each year, each
of these equipment will incur $8,500
maintenance cost. It is assumed that the farm will commence its
operations at the beginning of the next
financial year: 1 July 2022.
Before starting this new operation, HFC will need to redevelop and
renovate the warehouse at the farm.
HFC paid $10,000 for consultation fee and $6,000 for legal fee to
develop a building plan for the
warehouse. The building is expected to cost $200,000. Assume that
HFC is not able to claim any annual tax
deduction for the capital expenditure to the renovation of the
building until the business is sold.
To commence the farm operation, HFC will also need to invest
$50,000 in net working capital. This
amount will change annually and has to be maintained at 5% of sales
throughout the life of the project.
Investment in NWC will be recovered in full by the end of the
project.
Revenue projections from the farm for the next five years are as
follows:
Year 1 Year 2 Year 3 Year 4 Year 5
Beginning 1/7/2022 1/7/2023 1/7/2024 1/7/2025 1/7/2026
Ending 30/6/2023 30/6/2024 30/6/2025 30/6/2026 30/6/2027
Production quantity (tons) 120 140 170 185 185
Price (per tons) $9,100 $9,050 $9,100 $9,145 $9,195
Operating variable costs associated with the new business including
material costs and labour costs.
Estimated material costs per tons in year 1 is $2,000 and this cost
will increase by 10% every year. The
farm will require about 10 workers working for 8 hours a day, 200
days per year. The pay rate is flat at
$27.5/ hour including superannuation. Annual operating fixed costs
associated with production (excluding
depreciation) are $100,000. Existing administrative costs are
$600,000 per annum. As a result of the new
operation, these administrative costs will increase by 30%. The
company is subject to a tax rate of 30% on
its profits.
Meanwhile, HFC is currently financed by 60% of equity and 40% of
debt. Company’s bond is traded at a
price of $980. The bond has 10-year term, 8% coupon rate paid
semi-annually and face value of $1,000. In
Semester 1, 2020
addition, company’s equity has a beta of 1.2 while the risk-free
rate in the market is 3% and market
portfolio return is estimated to be 12%.
Catherine, the company CFO would like you to help her examine the
viability of the project for the next
five years, taking into account the projections of sales and
operations costs prepared by company’s
accountants.
Your tasks:
Based on the information in the case study, Catherine has asked you
to write a report to HFC’s
management advising them as to the best course of action regarding
this project. Your report should
address the following specific questions asked by HFC’s
management:
1. Discuss which costs are relevant for the evaluation of this
project and which costs are not. Your
discussion should be justified by a valid argument and supported by
references to appropriate
sources
2. Determine the initial investment cash flows, termination cash
flows and estimate all cash flows
associated with the project over 5 years. It is assumed that where
relevant, capital expenditures are
expended throughout the year, while cash flows relating to revenue
and operating costs occur at the
end of the year. You will need to broadly describe the method used
for determining those cash
flows.
3. Calculate the project’s payback period. Ignore the time value of
money for this calculation. Briefly
comment on your results.
4. Estimate the Net present value (NPV) and internal rate of return
(IRR) of the project, assuming that
the initial investment is funded by both debt and equity capital
with the proportion of debt and
equity similar to the current capital structure. Assume further
that the business could be sold at the
end of the five years for $1.5 million. This figure includes the
value of the equipment, premises, and
capital gain from the business. Briefly comment on your results and
make appropriate remarks on
the assumptions made for these calculations if necessary.
5. Using sensitivity analysis, recalculate NPV in Q4 using the
scenario of a decrease in project sales
by 10% annually. Briefly comment on the results.
6. Using sensitivity analysis, recalculate NPV in Q4 if the project
is funded entirely by equity (retained
earnings and new share issuance). Briefly comment on the
results
7. Produce an estimate of change in cost of equity (and discount
rate of the project) and the estimated
cash flows of the project given the current situation of COVID-19
in Australia. How would the
NPV of the project change? What is your recommendation to protect
the project against adverse
impact of the pandemic?
Semester 1, 2020
8. In view of your answer to Point 4 to point 7 above, advise
HFC’s management as to whether they
should go ahead with the investment project. In your
recommendations, you may wish to suggest
possible refinements in the method used for evaluating this
project.