2. CapitalBudgetingThea2MilkCompanyLimited(A2M)[30marks]

Answer the below questions in your word file and refer to your excel spreadsheet as a supporting document. Upload your excel spreadsheet under Excel Submissions.

.

Page 3

All amounts are in $AUD. The A2M board of directors (BoD) is exploring the opportunity to vertically integrate the business by acquiring one of its current suppliers. The BoD has instructed, one of the Big 4 Consulting firms to perform a screening process amongst the best dairy farms in Australia with the goal of selecting potential candidates. The firm is asking $100,000 dollars as a fixed fee for its consulting services. The report generated by the consulting firm has identified two different dairy farms that can fit the A2M business model. Project A has an initial outlay of dollars $100 million and Project B has an initial outlay of $150 million. Project A will produce 85,000,000 liters of milk starting at the end of year 1 until the end of year 5 and 50,000,000 liters of milk starting at the end of year 6 until the end of year 10. It will also incur working capital expenses at the end of year 6 to 9 of $5 million (this working capital will not be recovered). Project B will produce 100,000,000 liters of milk starting at the end of year 1 until the end of year 10. It will also incur working capital expenses at the end of year 1 to 3 of $2 million (this working capital will not be recovered). Assume that the average selling price (farmgate price) of a liter of milk is $0.5 over the ten years. The operating costs of both projects will be 30% of the revenues from year 1-10. Both investments will be depreciated on a straight-line basis over ten years to 0 book value. A2M has estimated that the dairy farms can be sold at the end of year 10 respectively for $50 million (Project A) and 75 million (Project B).The tax rate is 30%. All cash flows are annual and are received at the end of the year. The weighted average cost of capital for both projects is 10%.

a) CalculatetheFCFstoeachproject[10marks]

b) What is the NPV for each project? [5 marks]

c) What is the Discounted Payback Period for each project? [5 marks]

d) What is the IRR for each project? [5 marks]

e) SupposethattheA2Mmanagementpaybackruleis6years.Basedonyouranalysisinb), c) and e) which project should be chosen? Justify your answer with reference to theory. What other elements could be taken into consideration when selecting the project?