Harris Seafood
Question Number One (1) Value the processing plant proposal. Ignore the Industrial Revenue Bond financing. Assume: Market Risk Premium 8.8%, Riskless Rate 11.41%, and Harris Long Term Debt Rate 13.5%.
Our approach to valuing the processing plant can easily be decomposed into three distinct steps first, find the value of the foreseeable free cash flows. Next, calculate the terminal value of the project. Finally, take the present value of those flows. The next few paragraphs walk through each of these steps in order of progression.
In the first step we analyze the data and calculate the free cash flow from the inception of the project to the foreseeable future.
We opted to use Exhibit 7, which incorporates an 11%
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Since this project is a going concern, the levered terminal and present values are calculated using the weight average cost of capital (WACC) as the discount rate, which we calculate to be 16.17%.
Step Three: Draw out a timeline, and then take the present value of all cash flows Discounted Cash Flows | 1980 | 1981 | 1982 | 1983 | 1984 | 1985 | 1986 | TerminalIn 1986 | $4,942.28 | (10,035.00) | (2,621.00) | (4,256.00) | (458.00) | 1,803.00 | 1,998.00 | 2,246.00 | 45,795.69 |
Question Number Two (2) Is the pro-forma statement in Exhibit 7 credible? Why or why not?
We do not think the pro-forma statement in Exhibit 7 is credible.
1. The case explicitly discusses the volatility inherent in consumers’ demand for shrimp, pointing out that consumers are likely to forego shrimp entirely or substitute it with a less expensive product. In spite of this economic sensitivity, Exhibit 7 and Exhibit 6 (the 0% inflation scenario) show the exact same consumption of shrimp each year. 2. Management has no experience in this industry. Shifting the organization away from shrimping and into a processing plant will require a highly skilled management team and the Exhibit does not indicate that any new senior hires will be brought on board to help manage the new plant. This undermines our ability to rely on the forecast as a whole. 3. Exhibit 7 applied an 11% inflation rate to every single financial line throughout the
The appropriate discount rate was calculated using WACC formula as shown in the ‘WACC’ exhibit using the following assumptions:
1.1. Review principles of estimating project cash flows. Suggested reading: Ch. 9 “Capital Budgeting and Cash Flow Analysis” in “Contemporary Financial Management”, 11th ed. by Moyer, McGuigan, and Kretlow.
Thus, final free cash flows for the project come out to be $-3.750 million, $0.889 million, $2,563 million, $5,719 million and $2,388 million for years 2011, 2012, 2013, 2014 and 2015 years respectively.
General speaking, WACC is the rate that a company’s shareholders expect to be paid on average to finance its assets, and it is the overall required return on the firm as a whole. Therefore, company directors often use WACC to determine whether a financial decision is feasible or not. In this case, I will choose 9.38% as discount rate. The reason why I choose 9.38% as discount rate is because the estimated Debt/Equity is 26% under the assumptions by CFO Sheila Dowling, which is most close to 25% of Debt/Equity from the projected WACC schedule. There might be some flaws existing by using WACC as discount rate. As we know, the cost of debt would be raised significantly as the leverage increased. The investment will definitely increase the firm’s current debt. So, the cost of debt would not keep at 7.75%.
Here is a rundown of the variables we used to first determine the cash flows for Years 0 through 10: depreciation of equipment over the 10 years, sales minus COGS to identify gross profit, summed expenses (advertising, start-up, and Jell-o erosion only; the test market expense in Year 1 is considered a sunk cost and thus should not be included), and subtracted taxes to come up with the cash flow. When assessing the below issues, the team concluded the following
Before moving forward to compute the present value of these cash flows, a terminal value is required to forecast the long term value of the company after 5 years. . Following formula is used to calculate the terminal value.
General Foods is a large corporation organized by product lines. They are evaluating Super Project, the manufacture of a new powdered dessert. Crosby Sanberg, a financial analysis manager, must determine the value in accepting the proposal, along with J.C. Kresslin, the Corporate Controller. The Super Project will increase profit with a payback period of less than ten years. The proposed capital investment for the project is $200,000 ($80,000 for building modifications and $120,000 for machinery and equipment) and production would take place
First of all we calculate the initial development cost of the system then in the second step we find out approximate calculation of annual benefits. The third step is calculation of annual operating costs. In the last step we calculate the payback period cost of project/annual cash inflows or initial investment/periodic cash flow
See Table 1: Expected non-operating cash flow when the project is terminated at year 4 = 165,880$
Star Appliance is looking to expand their product line and is considering three different projects: dishwashers, garbage disposals, and trash compactors. We want to determine which project would be worth doing by determining if they will add value to Star. Thus, the project(s) that will add the most value to Star Appliance will be worth pursuing. The current hurdle rate of 10% should be re-evaluated by finding the weighted average cost of capital (WACC). Then by forecasting the cash flows of each project and discounting them by the WACC to find the net present value, or by solving for the internal rate of return, we should be able to see which projects Star should undertake.
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If we look at the financial summary of M.L.I we can calculate how much Winkler can bid for this company. We can calculate Net Present Value, Indicial Rate of Return and Payback period for this project. If we take last year and estimated after tax Income as a projection and investment of $2 million we can calculate: