Farming of Aquatic Organisms - Accounting and Finance Assignment Help

Assignment Task

Task

Assessment Description:

Tas Farm Pty Ltd is a company in aquacultural industry specialised in farming of aquatic organisms. TF 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, TF will need to redevelop and renovate the warehouse at the farm. TF 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 TF 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, TF will also need to invest $50,000 in net working capital. This amount will change annually and must 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.

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, TF 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 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%.

Tracy, 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. 

Tasks:

Based on the information in the case study, Tracy has asked you to report to TF's management advising them as to the best course of action regarding this project. The report should address the following specific questions asked by TF's management:

1. Discuss which costs are relevant for the evaluation of this project and which costs are not. 

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. Also 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 the 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 the 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?

8. In view of your answer to Point 4 to point 7 above, advise TF'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.

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