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Description: In-depth case analysis report requiring students to apply tools and theories covered throughout the subject and make recommendations.
Due Date: 5 pm Friday 8 April 2022 (Week 12)
This case analysis requires students to apply the skills and knowledge they have learnt within the subject and make recommendations based on a thorough analysis of the information provided while outlining any relevant limitations. The report is marked out of 100 in total. Part A: Cost of Capital is worth 25 marks, Part B: Asset Expansion is worth 30 marks, Part C: Asset Replacement is worth 25 marks, and Part D: Discussion of Limitations is worth 20 marks.
It is recommended students work on this assessment progressively throughout the later weeks of the semester as we progress through the required material:
- Week 9: Read the case analysis and compute the specific cash flows (NINV, NCF, etc.) detailed in the case (Part B and Part C). Reflect on issues, risks, missing information, etc.
- Week 10: Apply initial capital budgeting decision models for the projects detailed in Part B and Part C. Reflect on issues, risks, missing information, etc.
- Week 11: Compute the cost of capital in Part A and utilise this value to evaluate the projects detailed in Part B and Part C. Make an accept/reject the decision and provide a necessary rationale.
- Week 12: Outstanding work includes an analysis of capital budgeting and risk. Review Topic 11 (refer to chapter 11 of the prescribed textbook) and use simulations and sensitivity analysis to assess financing and investment computations. Detail any apparent limitations to the recommendations provided throughout the report in Part D.
Upon submission of this assessment, you acknowledge and agree to the following:
- I declare that I am the person as indicated by the student identification number associated with this assessment submission.
- I acknowledge and agree that I have read and understood the University’s Academic Integrity Policy and Discipline Regulations and that the submitted work is my own and does not breach these regulations.
- I will not share this assessment or my answers at any time, even after the conclusion of the assessment.
- I acknowledge that the assessor may:
- Communicate a copy of this assessment item to a plagiarism checking service which may then retain a copy of the item on its database for the purpose of future plagiarism checking; and
- Submit the assessment item to other forms of plagiarism checking.
The submitted report should include (at least) the following components: title with student number, executive summary, review of the workings required to compute the cost of capital and evaluate the two projects, list of assumptions made in each part, interpretation of relevant computations, discussion of any given recommendations, and a discussion of any relevant limitations to the provided recommendations.
This is a professional report and should be formatted as such – failure to do so can result in a penalty of up to 20% of marks in each part. Students are recommended to take into consideration the APA style formatting guidelines. Reports should not exceed 12 pages, including the appendix. Excel worksheets will not be accepted for marking, however, any relevant tables and graphs developed in Excel may be included in the report if they are embedded (i.e., no pictures).
Case Analysis Details in FINC71-101 Fundamentals of Finance
You have recently been employed by Golden Barrel Distillery – a publicly listed Australian company known for producing single malt whisky and rum products. The business has several operations around Tasmania’s hinterlands, with its head office located in Hobart. You have been appointed to the senior financing team and have been tasked with evaluating the profitability of two proposed capital investments.
Part A: Cost of Capital [25 Marks]
The latest annual reports and market data provide the following information regarding the current financial structure of Golden Barrel Distillery:
- Recently established corporate bank loan with a $12,500,000 principal amount. The loan requires the end of monthly repayments of $189,393.62 over the next 6 years, with interest compounding monthly.
- Unsecured notes offer investors a 3.7% per annum coupon rate, paid semi-annually. The 93,000 outstanding unsecured notes mature in 8 years, exhibit traditional $1,000 face values, and are currently trading for $1,012 each.
- Debentures maturing in 17 years with $1,000 denominations, trading for $992 each. The 210,500 outstanding debentures pay bondholders annually, based on a 4.3% per annum coupon rate.
- Cumulative Class A preferred stock trading for $27.83 each, with 425,000 outstanding in total. These preferred stocks have a stated annual dividend of $2.30 per share.
- Cumulative Class B preferred stock trading for $102.68 each, with 780,000 outstanding in total. These preferred stocks have a current dividend of $4.93 per share, which is indexed annually with inflation.
- Common stock trading for $16.24 each, with 60,500,000 outstanding in total. Golden Barrel Distillery has seen an average growth of 6.5% per annum over the past few years due to the growing demand for Australian made whisky. This growth is expected to continue for the next four years, before stabilising at a more moderate 3% to 4% thereafter. The company directors have just paid a dividend of $1.39 per share for the last 12 months.
The Reserve Bank of Australia has indicated inflation rates are expected to remain stable at roughly 3% per annum for the foreseeable future. Golden Barrel Distillery is subject to a 25% corporate tax rate.
What is Golden Barrel Distillery’s weighted average cost of capital (WACC)?
Part B: Asset Expansion Project [30 Marks]
You have recently been informed that Golden Barrel Distillery is considering the development of a new product offering, specifically the launch of a 20-year-old double barrel single malt whisky. The new product is a critical feature in a draft competitive bid being prepared by the company to exclusively supply a national alcohol retailer. You are required to evaluate the project before it is submitted to the CFO for final review.
Essential information relating to the project has already been prepared by the financing team, alongside the assistance of operational managers. The project calls for Golden Barrel Distillery to produce and deliver 506,250 bottles of the new 20-year-old whisky over a 12-year exclusivity period. The proposed selling price to the retailer, inclusive of shipping fees, is fixed at $86 per bottle. The product is anticipated to be sold by the retailer at a recommended retail price (RRP) of
$140 per bottle but maybe discounted to increase product demand and awareness. While Golden Barrel Distillery would be required to supply the retailer for a 12-year period, lead times in developing and finalising the new product are estimated to be an additional three years – thus sales relating to the project will not commence until year four of the projects 15-year life. Golden Barrel Distillery is proposing to supply the following quantities per year to the national retailer:
While you have previously evaluated projects in other industries before, this bid is unusual in a few ways. First, if accepted by the national retailer, this project would commit Golden Barrel Distillery to a fixed-price long-term contract. Second, producing the new single malt whisky would require a significant upfront investment to purchase machinery, bottle mouldings, necessary casks, and refurbish one of Golden Barrel Distillery’s existing buildings/plants.
Other details relevant to the appraisal of the project include:
- The negotiated price paid by the national retailer per bottle is fixed for the duration of the contract, along with the specified quantities each year.
- The excise duty on spirits is currently $92.81 per litre of pure alcohol – thus, Golden Barrel Distillery is required to pay roughly $28.26 (700ml bottled at 43.5%) per bottle sold, in addition to the marginal tax paid on annual net income. This excise duty is anticipated to remain constant for the foreseeable future and should be treated as an operational expense.
- Cost of goods includes fixed costs of $440,000 per year plus variable costs of $9.60 per bottle. These costs are expected to increase at the annual inflation rate.
- Working capital is expected to average about 15 per cent of annual sales.
- The plant to be utilised for this project (titled Refined Grain Estate) was purchased in 1964 and is now idle, due to the company previously centralising their production sites. The plant has been fully depreciated, except for the original purchase price of $160,000.
- The idle plant is in a valuable agricultural valley, with recent valuations estimating Refined Grain Estate could be sold immediately, or in the near future, for $10.8 million (inclusive of the land). Estates in the area are projected to appreciate roughly 2.75% per annum over the next 20 years.
- Refurbishing the plant is anticipated to cost $1.9 million and would be depreciable on a straight-line basis over the next 20 years.
- The necessary machinery and equipment are projected to cost $2.1 million in total and would be depreciated on a straight-line basis over the next 15 years.
- The additional casks required to be purchased for the new product are estimated to cost
$240,000 in total and would also be depreciated on a straight-line basis over 15 years.
- The refurbished plant, machinery, equipment, and casks are all expected to last for many years if maintained. However, due to its strong competition in the single malt whisky market, it is unclear whether a subsequent supply agreement with this national retailer or another could be obtained once this proposed contract ends. The capital investments required for this project are specialised for this new product offering, and hence the resale value at the end of 15 years is estimated to be zero at this stage.
Given the stature of the client for this proposed contract, the annual sales aspect is considered low risk and hence it is believed the discount rate used for evaluation purposes could be 2% lower than Golden Barrel Distillery’s standard WACC.
Golden Barrel Distillery’s business development manager has recently received a confidential letter of interest. It contains the details of a proposed offer from a start-up distillery to purchase the Refined Grain Estate (land and plant) for $8.7 million – although, you have noticed the offer is subject to Council approval for the development of the land and merger of titles with an adjacent property.
Should you recommend submitting the bid for this competitive tender at the proposed price of $86 per bottle, or make a counteroffer? Comment on critical issues to be considered, including the offer from the start-up distillery. This report will be distributed to a wide audience (mixed financial background) at Golden Barrel Distillery, and as such, must include at least three decision models, along with appropriate interpretations, discussions of assumptions, and whether the presented decision models present conflicting recommendations.
Part C: Asset Replacement Project [25 Marks]
Golden Barrel Distillery also has an existing operation producing unbranded grain whisky, which is marketed to local distilleries as a base for their blended whisky products. The company currently uses specialised production machines and storage equipment to produce this base grain whisky, which was all purchased seven years ago. This capital investment is being depreciated on a straight-line basis over 10 years; have three years of remaining life and a current collective book value of
$825,000. It is estimated these machines could be sold today for $685,000. Replacement machines could be purchased today at a cost of $3,650,000. The replacement machines have an estimated useful life of 10 years, and an estimated collective salvage value of $210,000 at the end of their useful life. These machines can be depreciated for tax purposes over an eight-year straight-line schedule.
The division manager expects, although with voiced uncertainty, that the replacement machines would permit an output expansion of 52,484 units in the first year, 58,926 units in the second year, 68,923 units in the third year, 75,247 in the fourth year, and 78,152 units each year thereafter – from the current annual average output of 124,800 units. It is also anticipated this additional output can be sold for a current average price of $6.95 per unit. While the division manager has expressed some reservations regarding the possible revenue gained from these new machines, one of the big advantages of this project is greater operating efficiency. Again, without total certainty, the managing director expects to save $2.46 per unit in current dollars of the current operating costs over the longer term, but in the first two years, the savings would only be half this expected amount per unit (while workers learn how to effectively use the new machines). This project would require Golden Barrel Distillery to initially increase inventories by $130,000, while accounts payable would simultaneously increase by $60,000.
You are required to evaluate whether Golden Barrel Distillery should undertake the proposed replacement project? Comment on critical issues to be considered. This report will be distributed to a wide audience (mixed financial background) at Golden Barrel Distillery, and as such, must include at least three decision models, along with appropriate interpretations, discussions of assumptions, and whether the presented decision models present conflicting recommendations.
Part D: Discussion of Limitations [20 Marks]
Given the uncertainty expressed towards many of the critical case factors, comment on any limitations to the cost of capital developed in Part A or the recommendations provided in Part B and Part C – along with any assumptions made. Make sure you comment on how uncertain factors impact your valuations and demonstrate the use of recommended techniques to address these concerns.
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