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BAP53 Corporate Finance

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BAP53 Corporate Finance

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Course Code: BAP53
University: Universal Business School Sydney

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Country: Australia

Question:

You have recently graduated with a degree in finance. Your employer, Bega Cheese wants you to work with the provided to data to address the given problemsa.Determine the weighted average cost of capital for Bega Cheese. 
b.Should the management go ahead with its proposed project of introducing the range of yogurt under the normal conditions as stated previously? 
c.Should Bega Cheese go ahead with its proposed project of introducing the ranges of yogurt under the following best case and worst case scenarios?Best – Case ScenarioSelling 2,500,000 units at a price of $1.24 per unit, with variable production costs of $0.22 per unit.Worst – Case ScenarioSelling 950,000 units at a price of $1.32 per unit, with variable production costs of $0.27 per unit. 
d.What would you do as the financial analyst? Which investment would you recommend, and why? 

Answer:

Introduction:
In this report an attempt is to evaluate the project by the financial analyst so that the project could be evaluated. The report provides a detailed analysis of the project that includes determination of weighted average cost of capital and determination of NPV under different situation (Damodaran 2016). The main aim of this analysis is to provide a detailed understanding so that the financial analyst could make important decision.
Determination of Weighted Average Cost of Capital
This section of the report provides detailed calculation of the weighted average cost of capital. In order to calculate WACC the cost of equity and cost of debt is calculated. The cost of equity is calculated using the Capital Asset Pricing Model.
Cost of Equity

Calculation of Cost of Equity using CAPM

Particulars

Amount

Risk Free Rate

3.5%

Beta

1.13

Market Return

12.52%

Cost of Equity

14%

Cost of Debt

Calculation of Cost of Debt

Particulars

Amount

Cost of Debt

10%

Tax Rate

34%

After Tax cost of debt

7%

Weighted Average Cost of capital

Calculation of Weighted  average cost of capital

sources of fund

Market Value

Weightage

cost of capital

CXW

Equity

$1,300,550,000.00

98%

14%

0.13407027

Bond

$27,702,000.00

2%

7%

0.00137649

Total

        1,328,252,000.00

100%

 

 

Weighted  average cost of capital

 

 

 

13.54%

Analysis of the Proposal

Statement showing calculation of NPV

Particulars

Rate

1

2

3

sales unit

 

1250000

1250000

1250000

selling price

 

$1.25

$1.25

$1.25

Total Sales

 

$1,562,500.00

$1,562,500.00

$1,562,500.00

less: variable cost

0.24

$300,000.00

$300,000.00

$300,000.00

contribution

 

$1,262,500.00

$1,262,500.00

$1,262,500.00

less: fixed cost

 

$250,000.00

$250,000.00

$250,000.00

Less: depreciation

 

$1,000,000.00

$1,000,000.00

$1,000,000.00

Profit

 

$12,500.00

$12,500.00

$12,500.00

Tax

34%

$4,250.00

$4,250.00

$4,250.00

Profit After Tax

 

$8,250.00

$8,250.00

$8,250.00

Add:

 

 

 

 

Depreciation

 

$1,000,000.00

$1,000,000.00

$1,000,000.00

Terminal Value

 

 

 

$300,000.00

Operating Cash flow

 

$1,008,250.00

$1,008,250.00

$1,308,250.00

Discounting Factor

 

0.8807

0.7757

0.6831

Present Value of Cash flow

 

$887,976.46

$782,050.28

$893,697.22

Total Present Value

 $   2,563,724

 

 

 

cost of investment

 $   3,000,000

 

 

 

NPV

 $     -436,276

 

 

 

 

Statement showing Calculation of Depreciation

Particulars

Amount

Initial Investment

$3,000,000.00

Number of year

3

Depreciation

$1,000,000.00

In the current case, the Bega Cheese proposed to arrange product mix a range of Yogurt products to capitalise on the growing demand for natural yogurt range as decided by the board of director (Ehrhardt and Brigham 2016). The calculation above indicates NPV of the project under normal scenario. The calculation indicates that under normal circumstances the NPV of the project is negative $436276. Therefore under normal circumstances the current project is generating negative return.
Analysis under Best and worst case scenario
Best Case scenario

Statement showing calculation of NPV (Best Case)

Particulars

Rate

1

2

3

sales unit

 

2500000

2500000

2500000

selling price

 

$1.24

$1.24

$1.24

Total Sales

 

$3,100,000.00

$3,100,000.00

$3,100,000.00

less: variable cost

0.22

$550,000.00

$550,000.00

$550,000.00

Contribution

 

$2,550,000.00

$2,550,000.00

$2,550,000.00

less: fixed cost

 

$250,000.00

$250,000.00

$250,000.00

Less: depreciation

 

$1,000,000.00

$1,000,000.00

$1,000,000.00

Profit

 

$1,300,000.00

$1,300,000.00

$1,300,000.00

Tax

34%

$442,000.00

$442,000.00

$442,000.00

Profit After Tax

 

$858,000.00

$858,000.00

$858,000.00

Add:

 

 

 

 

Depreciation

 

$1,000,000.00

$1,000,000.00

$1,000,000.00

Terminal Value

 

 

 

$300,000.00

Operating Cash flow

 

$1,858,000.00

$1,858,000.00

$2,158,000.00

Discounting Factor

 

0.8807

0.7757

0.6831

Present Value of Cash flow

 

$1,636,360.29

$1,441,159.84

$1,474,182.00

Total Present Value

 $   4,551,702

 

 

 

cost of investment

 $   3,000,000

 

 

 

NPV

 $   1,551,702

 

 

 

The calculation above indicates that under best circumstances the project will provide positive return of $1551702. That means under best circumstances the project is acceptable.
Worst Case Scenario

Statement showing calculation of NPV (Worst Case)

Particulars

Rate

1

2

3

sales unit

 

950000

950000

950000

selling price

 

$1.32

$1.32

$1.32

Total Sales

 

$1,254,000.00

$1,254,000.00

$1,254,000.00

less: variable cost

0.27

$256,500.00

$256,500.00

$256,500.00

Contribution

 

$997,500.00

$997,500.00

$997,500.00

less: fixed cost

 

$250,000.00

$250,000.00

$250,000.00

Less: depreciation

 

$1,000,000.00

$1,000,000.00

$1,000,000.00

Profit

 

-$252,500.00

-$252,500.00

-$252,500.00

Tax

34%

-$85,850.00

-$85,850.00

-$85,850.00

Profit After Tax

 

-$166,650.00

-$166,650.00

-$166,650.00

Add:

 

 

 

 

Depreciation

 

$1,000,000.00

$1,000,000.00

$1,000,000.00

Terminal Value

 

 

 

$300,000.00

Operating Cash flow

 

$833,350.00

$833,350.00

$1,133,350.00

Discounting Factor

 

0.8807

0.7757

0.6831

Present Value of Cash flow

 

$733,940.17

$646,388.89

$774,218.80

Total Present Value

 $   2,154,548

 

 

 

cost of investment

 $   3,000,000

 

 

 

NPV

 $     -845,452

 

 

 

The calculation above indicates that under worst case scenario the NPV of the project is negative $845452.
Conclusion
In the given situation based on the analysis the financial analyst derived that the project is not suitable under normal and worst case scenario. However, the project is expected to give positive return only in the best scenario. Therefore, based on the analysis and calculation shown above it can be said that the project should be implemented if the best case scenario can be maintained.
Reference
Damodaran, A., 2016. Damodaran on valuation: security analysis for investment and corporate finance (Vol. 324). John Wiley & Sons.
Ehrhardt, M.C. and Brigham, E.F., 2016. Corporate finance: A focused approach. Cengage learning.
Fracassi, C., 2016. Corporate finance policies and social networks. Management Science, 63(8), pp.2420-2438.
Scholes, M.S., 2015. Taxes and business strategy. Prentice Hall.

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