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Corporate Finance

 

There is a word limit of 1500 words in total – appendices (including, for example calculations) can be attached and will not be counted in the word limit.

Part 1 (10 marks)

Future Waste (FW) collects liquid/solid waste from restaurant grease traps. The waste is taken to FW’s waste processing facility, where the solid component is separated from the liquid component. The liquid component is treated and discharged into the sewer system. At present the solid waste component is sold to a third party, who converts the waste into fertiliser. However FW is considering constructing a new “waste-to-fertiliser” production facility that converts solid waste into fertiliser. As Chief Financial Officer (CFO) of FW, you have been given chief responsibility for evaluating the potential construction of a waste-to-fertiliser facility.

The facility would be constructed on land adjacent to FW’s waste processing facility. FW purchased this land 2 years ago for $900,000. The land is currently rented to a crane hire business for $50,000 per annum.

You have previously engaged a consultancy firm to provide advice on the costs and benefits of the project. The consultancy firm charged $300,000 for their services.

The expected construction costs for the project are $16 million. Construction would occur in 2016 with production expected to begin in 2017. The project has a life of 10 years and construction costs will be fully depreciated over 10 years on a straight line basis for both accounting and tax purposes. Net of remediation costs the project is not expected to have any sale value at the end of 10 years.

In 2015 FW produced 420,000 tonnes of solid waste per annum. Management believes that the following tonnages will occur at the following stated probabilities.

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Tonnage Forecast Probability
370,000 30%
420,000 65%
450,000 5%

 

Solid waste is currently (i.e. 2015) sold to a third party for $4 per tonne, with prices expected to grow in line with inflation. Solid waste is converted into fertiliser at a rate of 5:4. That is, 5 tonnes of solid waste makes 4 tonnes of fertiliser.

Current most-likely estimates of the fertiliser prices over the life of the project are $10 per tonne; however management believes that the following prices will occur at the following stated probabilities.

Price Forecast (Nominal $2015/tonne) Probability
8 30%
10 60%
12 10%

 

Fertiliser prices are expected to grow in line with inflation.

In 2017, variable operating costs are expected to be $3 per fertiliser tonne, while fixed operating costs are expected to be $1.0 million per annum. In addition, working capital costs are expected to total 15% of sales.

For the cost of capital, you should refer to data on listed waste companies in part 2 of this assignment. Assume a risk-free rate and an equity market return of 4% per annum and 10% per annum respectively. The risk profile of this project is considered to be in line with other aspects of FW’s business.

Expected inflation is 5% per annum. The corporate tax rate is 30%.

Evaluate whether the new project should proceed using NPV/IRR analysis. Clearly state your assumptions. Explain and discuss your results. As part of your answer you should conduct a NPV sensitivity analysis with respect to fertiliser prices and tonnages. You should assume that all cash flows occur at the end of the year.

Part 2 (10 marks)

FW is also considering an initial public offering (IPO) of its shares. The IPO will give FW better access to capital for expansion. It is currently privately owned by a family, and some members of the family have devoted most of their lives to the survival of the business. Now the business has expansion plans (such as the fertiliser plant in part 1 and geographic expansion), and an IPO would offer the company scope to raise public equity.

As a first step to achieving an IPO, the CFO has been discussing valuation with investment banks. The board has requested a valuation based on the discounted dividend model and comparable multiples.

Following are key financial metrics for FW. You should assume that these financials capture all relevant financial information for FW.

FW Financials
2010 2011 2012 2013 2014
Sales 32.0 27.0 30.0 33.0 35.0
EBITDA 7.5 -2.2 5.1 7.6 8.3
Margin 23.4% -8.1% 17.0% 23.0% 23.7%
           
Capital Expenditure 1.5 0.8 1.4 1.6 1.8
Free Cash Flow 6.0 -3.0 3.7 6.0 6.5
Free Cash Flow Retention Rate 0.0% 0.0% 0.0% 0.0% 0.0%
Dividends 6.0 n/a* 3.7 6.0 6.5

 

* In 2011 the owners injected $3.0 million into the company to pay expenses and for working capital requirements.

The company fell on hard times in 2011. A brave decision was made by its owners to inject capital and restructure the business.

According to company management, current margins are expected to be sustainable, and current capital expenditure is adequate. Management also believes that sales growth of 5% per annum is realistic.

There are currently four listed waste companies in Australia. Key metrics are shown below:

Listed Waste Companies EBITDA Multiples
Sales $m p.a. Beta 2012 2013 2014
Mucho Waste 478 0.8 12.1 11.2 11.6
Waste 4 u 56 1.4 9.6 8.9 9.6
Nice Waste 49 1.2 8.4 8.1 8.3
Waste Services 78 1.3 8.6 7.8 8.5

 

FW is not currently anticipating any debt funding. That is, FW will be fully funded with equity.

Set out your valuations in detail. Explain and discuss your results. 

MARKING GUIDE 

Part 1:

2 marks for clearly presenting (accurate) forecasts and assumptions in excel

2 marks for treatment of depreciation and tax

1 mark for treatment of working capital

1 mark for treatment of opportunity costs

1 mark for calculation of NPV and IRR

1 mark for cost of capital

1 mark for reaching valid conclusion based on analysis

1 mark for sensitivity analysis

Part 2:

3 marks for dividend discount model valuation

3 marks for comparable multiple valuation

4 marks for discussion of results

Note: Please attach the mark sheet provided to the back of your hard-copy submission.

 

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