Capital Budgeting - The a2 Milk Company Limited (A2M)

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".

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) Calculate the FCFs to each project [10 marks]

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) Suppose that the "A2M" management payback rule is 6 years. Based on your analysis in b),

c) and d) which project should be chosen? Justify your answer with reference to theory.

What other elements could be taken into consideration when selecting the project?

[5 marks]