1. Freedom Foods Group Limited (hereafter known as Freedom) ordinary shares are listed on the Australian Securities Exchange (ASX). According to the announcement made to the ASX on 22/03/2018 with the headline FNP - Retail Offer Booklet with Investor Presentation (hereafter Presentation) Freedom has invested over $300 million in recent years and plans further capital expenditure to increase financial returns. The Presentation states Freedom has undertaken a number of capital expenditure initiatives at Ingleburn and is now planning to further increase its Ultra-High Temperature (UHT) milk processing capacity by expanding the existing footprint. This short-term heating and cooling of milk prolongs the shelf-life of milk from several days to approximately twelve months. Before Freedom commits to the substantial capital expenditure (and other associated costs) of expanding its Ingleburn facility a financial analysis is needed to determine if it will contribute to the goal of creating wealth for its shareholders. 2. You are employed in Freedoms corporate finance department and have impressed senior management with your aptitude for financial analysis. This talent was developed through the practice-oriented assignments that you completed at University. The Chief Financial Officer (CFO) has asked you to perform a financial analysis of the planned Ingleburn factory expansion using a purpose-built preformatted EXCEL spreadsheet. The CFO has suggested you liaise with company employees from a variety of different departments to collect the information that is necessary to perform the analysis. You will also search through public documents such as ASX announcements to identify some of the information that will be required in your financial analysis, and to help answer questions about Freedoms equity and the recent equity issue. Your analysis will be provided to the Board of Directors who approve major capital expenditures such as the Ingleburn expansion.

3. The two substantial cash outflows associated with the expansion are the cost of the building and the equipment. The directors are accountable to the shareholders and so a rigorous financial analysis is necessary to be confident that the future cash flows justify investing in the UHT expansion project. The following paragraphs contain a substantial amount of information that has been gathered from across the business and it is your job to determine which information is relevant to the analysis.

4. Predicting the future cash sales of UHT milk production at the Ingleburn facility is based on the volume of milk production and the price per litre. Freedoms forecast of UHT volume produced at the current Ingleburn facility for 2019 and 2020 is specified in the table titled UHT Sites Installed Litres Capacity contained in the Presentation . Current predictions are for sales volume beyond 2020 to increase at an annual 1% rate. If Freedom proceeds with the expansion then total UHT production at Ingleburn (in millions of litres) is forecast to be 204 in 2019, 256 in 2020 and 257 in 2021. From 2021 total UHT production at an expanded Ingleburn facility is assumed to increase at 1% per annum relative to the forecast in 2021. Freedom achieved a sales price per litre of UHT milk in 2018 of $1.41 and is budgeting to achieve this price for the next two years. Competition is expected to cause this price to decrease by 2% p.a. each year for the subsequent eight years.

5. The cost per litre of raw milk required to produce UHT milk is based on the NSW farm gate milk as reported by Dairy Australia. Your estimate of the cost per litre for milk each year from 2019 to 2028 is assumed to be the same as the figure for 2016/17. No milk is wasted in the production of UHT milk. Therefore, the same quantity of raw milk purchased each year (as specified in paragraph 4) is transformed into the same quantity of UHT milk.

6. Freedom already owns a block of land adjacent to the existing factory at Ingleburn on which they plan to construct the new building. In 2001 when Freedom constructed the original $7 million Ingleburn facility they leased the land to a dairy farmer for $140,000 each year. At that time Freedom also purchased milking equipment at a cost of $300,000. At that time the milking equipment was determined to have a twenty-year life for taxation purposes and an assumed zero salvage value for depreciation calculations. Before the expansion can proceed Freedom must terminate the lease agreement with the dairy farmer and sell the milking equipment. The equipment has a scrap value today of $80,000. This years financial statements show the equipment is being depreciated at $15,000 per year and the balance sheet indicates a carrying value of $45,000. Because the $300,000 cash outflow relating to the equipment has already occurred the accountant suggests it be treated as a sunk cost in the analysis. Freedom will continue to lease the land if the UHT facility is not constructed.

7. In addition to the cost of milk, another substantial operating cost associated with the expansion is wages. You expect that the annual wages expense directly associated with the Ingleburn expansion will remain at $2.8 million each year for the foreseeable future.

8. The Presentation discloses that when Freedom closed its Taren Point factory it incurred $4.8 million associated with discontinuing operations. This cost was expensed in the half-year accounts ending 31 December 2017.

9. The capital cost of the Ingleburn building is budgeted to be $4.8 million today. Freedom proposes to use $2 million of the $3,573,000 cash on its balance sheet to pay for the building to reduce the cash cost to just $2.8 million. For taxation purposes the new building has a twenty-year life. However, Freedom will perform the financial analysis of the Ingleburn expansion over a ten-year time period. The Ingleburn expansion will also require $2 million worth of refrigeration equipment today. The Australian Taxation Office (ATO) confirms that refrigeration equipment has an eight-year tax life. In Freedoms experience, if refrigeration equipment is maintained properly it be operated effectively for ten years before requiring replacement. Freedoms management accountants depreciate all assets over ten years to match the lifespan of the factory expansion.

10. Throughout 2017 Freedom incurred $260,000 of expenses on external architectural plans relating to an enlarged Ingleburn facility. To ensure this expense is not wasted the directors plan to include it in the analysis as a cash outflow in 2018. This approach will ensure that historical business expenses can be recovered and allow it to generate the required return.

11. To maintain a strong credit rating, Freedom will borrow $1.2 million today to finance the Ingleburn facilitys expansion. The ten-year principal-and-interest loan has annual interest repayments of $147,949 (assuming a 4% p.a. rate). Freedoms accountant confirms that interest is classified as a business expense and is tax deductible.

12. There is an anticipated expense of $180,000 to install the equipment associated with the Ingleburn expansion, and a $50,000 cost to upgrade the electricity supply required to commence operations. According to the ATO both of these items are classified as a business expense. The manager of the Ingleburn facility would prefer to classify these expenses as assets and therefore depreciate them over the ten-year project life to give the appearance of higher profitability for the 2018 financial year. The manager is budgeting to achieve a net profit for 2018 of $1.22 million and increasing it by $150,000 for 2019.

13. You assume that the Ingleburn building can be sold for $1.9 million in the year 2028, and at any point in time the equipment will have a resale value of $650,000. In ten years time Freedom assumes that it will have cash holdings of $12 million. You note the ATO regulation that all non-current assets be depreciated to zero.

14. Substantial amounts of capital have been invested at the Ingleburn site in recent years, including $1.75 million on packaging machinery. Ingleburns existing repairs and maintenance expenses are budgeted at $400,000 for each of the next five years, increasing to $500,000 for the following five years. If Ingleburn does expand operations then a $1,500,000 expense will be incurred in five years time for repairs and maintenance of the equipment and building.

15. Freedoms existing Shepparton UHT facility has annual sales of $2.5 million. If Ingleburn expands then management believes that due to the national attention on highquality UHT milk that Shepparton will experience ongoing higher sales of $250,000 p.a.

16.

Freedom currently has $3.5 million of inventory and $570,000 of this amount is situated at the existing Ingleburn facility. Accounts receivable at the moment are $2.3 million. If the Board of Directors approve the Ingleburn UHT facility expansion you anticipate that accounts receivable will be $2.3 million and an additional $1.1 million of inventory will be necessary. Accounts payable will increase by $600,000 to $4.4 million.

17. The Presentation reveals that Veritas Securities Limited and UBS, AG Australia Branch are the lead managers and underwriters of Freedoms $200 million equity raising. Section 4.30 of the Presentation states the management and underwriting fee. You spend many hours explaining to Freedoms upper management the relevance of the equity raising fee in the capital budgeting analysis of expanding Ingleburns UHT milk production capacity.

18. Freedoms remuneration committee is planning to increase annual Directors fees by $200,000 whether the Ingleburn expansion occurs or not. If the expansion proceeds the general manager (GM) of the existing Ingleburn facility will receive a $50,000 salary increase for the increased responsibilities associated with managing a larger facility. The GM current annual salary is $225,000.

19. Freedoms required return is 9%. Assume the company tax rate will remain at 30%.

REQUIREMENTS

Your team must answer the following eight questions. All answers must be entered into the preformatted EXCEL spreadsheet available on UTSOnline. Questions 1 to 4 require information relating to the capital budgeting decision of the proposed Ingleburn expansion. Questions 5 to 8 require you to analyse Freedoms equity, and the recent equity issue.

Capital Budgeting Information (14 Marks) Present an itemised breakdown (and the total) for each of the following: 1. The cash flows at the start. 2. The cash flows over the life. 3. The cash flows at the end. 4. What is the NPV of the proposed Ingleburn expansion, and your recommendation and explanation?

Equity and Debt Information (6 Marks)

5. What is the percentage return on Freedom shares for the year 2017? Your return calculation must use the share price for the first and last ASX trading day for 2017, and include all dividends paid per share during 2017.

6. You have been discussing with the lead managers of the equity raising the value of Freedom shares. Freedom recently paid its dividend for the 1 st half of 2018 and equity analysts are forecasting that the dividend for the 2 nd half of 2018 will be two cents higher than the dividend in the 2 nd half of 2017. The total annual dividend for a particular year equals the sum of the 1 st half and 2 nd half dividend for that year (you may ignore the difference in timing). The total annual dividend for 2019 is forecast to increase by six cents compared to the total annual dividend for 2018, and then remain at the 2019 level for 2020, 2021 and 2022. From 2022 the annual dividend increases by an annual rate of 6%. If the required return on a Freedom share is 9%, what is a fair value for one Freedom share in the year 2018?

7. Which of the Key Risks in the Presentation best explains the risk that Freedoms bank might increase the interest rate on its long-term loan?

8. According to the Presentation, in terms of Freedoms balance sheet what is one advantage of the equity raising?