CASE STUDY Huonville Farming Co. Ltd (HFC) is a company in the aquacultural industry that specialises in farming aquatic organisms. HFC is considering opening a new farm near Huon Valley. This project would involve the purchase of 25 hectares of land at a price of $2,000,000 (Note that: The land is not subject to depreciation for accounting and tax purposes). In addition to that, the company will need to purchase ten special heavy equipment which cost $240,000 each. The equipment is expected to be in use for 6 years and after that, it will be scrapped without any residual value. Each piece of equipment will incur a $15,000 maintenance cost per year. It is assumed that the farm will first be in operation at the beginning of the next financial year: 1 July 2023. Before starting this new operation, HFC will need to redevelop and renovate the warehouse at the farm. This is expected to cost $450,000. It also paid $50,000 for the farm design and market research. Also note that if HFC is not running its own farm in the new lot of land, it can rent it out for $72,000 per year. Assume that HFC cannot claim any annual tax deduction for the capital expenditure on the renovation of the building until the business is sold. To start the operation of the new farm, HFC also needs to invest $85,000 in the net working capital which will be returned in half by the end of the project. Revenue projections from the farm for the next five years are as follows: Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Beginning 1/7/2023 1/7/2024 1/7/2025 1/7/2026 1/7/2027 1/7/2028 Ending 30/6/2024 30/6/2025 30/6/2026 30/6/2027 30/6/2028 30/6/2029 Production quantity (in tonnes) 280 300 310 305 290 290 Price (per ton) $9,110 $9,175 $9,225 $9,280 $9,350 9,360 Operating variable costs associated with the new business include material and labor costs. Estimated material costs of $2,080 per ton in year 1 and this cost will increase by 3.5% 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 $35/ hour including superannuation. Annual operating fixed costs associated with production (excluding depreciation) are $250,000. Existing administrative costs are $550,000 per annum. As a result of the new operation, these administrative costs will increase by 40%. The company is subject to a tax rate of 30% on its profits. Meanwhile, HFC is currently financed by 60% of equity and 40% of debt. The companys bond is traded at a price of $980. This bond has a 10-year term, 8% coupon rate paid semi-annually, and a face value of $1,000. It was issued to the market 2 years ago. In addition, the companys equity has a beta of 1.2. Catherine, 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 companys accountants. Your tasks on the written reports: Based on the information in the case study, Catherine has asked you to write a report to HFCs management advising them on the best course of action regarding this project. Your report should address the following specific questions asked by HFCs management: 1. Discuss which costs are relevant for evaluating this project and which are not. Your discussion should be justified by a valid argument and supported by references to appropriate sources 2. Determine the initial investment cash flow and estimate all operating cash flows associated with the project over the first five years. 3. Using the ASX 200 index as a proxy for the market portfolio and the Australian 5-year Treasury Note as the risk-free rate, determine the market portfolio return, the risk-free rate, and the required return of HFC according to CAPM. Calculate the cost of capital of HFC for the new farm project evaluation. (Hint: The market portfolio return is measured by the arithmetic average annual return of ASX 200 over 10 years and the annual return = daily return * the number of trading days in a year. You can download the trading data of ASX 200 from the Morning Star database). 4. Calculate the projects payback period and the management team aims to screen for projects with a recovery time of more than 4 years to be excluded. Assuming the business could be sold at the end of the six years for $1.2 million (excluding the land and including the machine, the warehouse, and other facilities on the farm). Briefly comment on your results. 5. Calculate the projects net present value (NPV), assuming that the initial investment could be sold at the end of the six years for $1.2 million (excluding the land and including the machine, the warehouse, and other facilities on the farm). Briefly comment on your results and make appropriate remarks on the assumptions made for these calculations if necessary. 6. Estimate the projects internal rate of return (IRR). Briefly comment on your results 7. Using sensitivity analysis, recalculate NPV using the scenario of a. A decrease in project sales quantity by 10% annually. b. An increase of the sale price by 5% annually c. An increase in material costs change from 3.5% to 4.5% d. An inflation rate of 3% p.a Briefly comment on the risk factors identified in the sensitivity analysis. 8. In view of your answer to the item (4) to item (7) above, advise HFCs 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. You also need to provide an Excel spreadsheet showing all calculations clearly. Please do not convert the Excel spreadsheet into Pdf file as we need to check your calculations shown in the spreadsheet.