CASE STUDY: The a2 Milk Company Limited In 2000 Dr Corran Mclachlan a research chemist from the Wairarapa and Howard Patterson an entrepreneur from Dunedin founded the A2 Corporation Limited to market milk, and milk products, that were free from the A1 (B-Casein) protein. The company had a difficult start with opposition from New Zealand's major milk-producing dairy cooperative (particularly over the health-claims made for the brand) but by 2003 it was able to launch its 2 and a2MILK brand products in New Zealand. Unfortunately during that year both Dr Mclachlan and Mr Patterson died and the company struggled financially and to help cash-flows the Company's Australian division was sold to a Singapore-based food and beverages conglomerate. The New Zealand division gradually grew both its product range and sales volumes and by 2006 was able to buy back the Australian division. A2 Corporations first profit announcement was made in 2011 and in March 2013 the company listed on the NZX. in April the following year it changed its name to The a2 Milk Company Limited and in March 2015 it dual listed on the ASX. The a2 Milk Company (2) currently operates in New Zealand, Australia and either in its own right or through joint ventures with local companies in China, the United States of America and the United Kingdom, a2 produces and markets not just A1 protein-free milk but a range of milk-based products such as whole milk powder, ice cream and yoghurt all manufactured using Al protein-free milk Through clever management of the release of its infant formula in China and after the announcement of an agreement with its previous opposition Fonterra, a2 shares leapt in value and by 2018 it had become New Zealand's largest (my market value) listed company The phenomenal growth that started in 2018 continued through 2019 with revenue and profits growing by 41% and 47% respectively and all markets, with the exception of the United Kingdom, demonstrating strong growth and high market penetration. In its 2019 Annual Report ax's Board Chair, David Hear stated: "The company enjoys a robust balance sheet which, combined with its continued strong cash generation, gives us the flexibility to support our growth potential in the future. The Board and management continue to evaluate a broad range of investment options designed to support our future growth aspirations. As a consequence, we do not anticipate paying dividends in the near-term The Investment Opportunity After your postgraduate study at the University of Auckland you were employed by a2 in its finance division. Your division works closely with the product development and marketing divisions and you have been working with colleagues from these areas on a new idea that reflects a2's objectives, as outlined by the chairman Research in the product development division has shown that a yoghurt product derived from the company's premium infant formula a2 Platinum is particularly beneficial in geriatric nutrition. Your marketing colleague believes that with appropriate promotion of these nutritional benefits such a product is likely to do exceptionally well, particularly in the US and China where the aging population represents an immense, untapped marketplace. She has asked you to produce a financial analysis that will support a proposal to the board to proceed with introduction of the new product to market. You have gathered the following detail to assist in your analysis The Investment Opportunity After your postgraduate study at the University of Auckland you were employed by a2 in its finance division. Your division works closely with the product development and marketing divisions and you have been working with colleagues from these areas on a new idea that reflects a2's objectives, as outlined by the chairman Research in the product development division has shown that a yoghurt product derived from the company's premium infant formula a2 Platinum is particularly beneficial in geriatric nutrition. Your marketing colleague believes that with appropriate promotion of these nutritional benefits such a product is likely to do exceptionally well, particularly in the US and China where the aging population represents an immense, untapped marketplace. She has asked you to produce a financial analysis that will support a proposal to the board to proceed with introduction of the new product to market. You have gathered the following detail to assist in your analysis: Financial Information Tables: Table 1 - Product Market Estimates Immediate total potential worldwide market for product is NZ$800 million revenue (equivalent) Total worldwide market is expected to grow by 5% annually Projected a world-wide market share is expected to be 3% in the first year of operation and increasing by 1% annually (i.e.4% of world-wide market in Y, 5% in Y, etc.) Table 2 - Marketing and Production Estimates Estimated life of investment - 5 years (the assumption is that by the end of this period new products will be available that will supersede the geriatric yoghurt product and production will cease). The initial investment in production facilities is expected to be $40,000,000 Marketing expenditure will commence immediately with a $10,000,000 investment in worldwide advertising and product awareness education (assume this all occurs in Y.) followed by four years of reducing marketing expenditure at the end of each subsequent year i.e. $7,000,000 in Yx: $5,000,000 in Y;$3,000,000 in Y and $1,000,000 in Ys. Sales revenue is expected to be $2.00 per item. Variable production costs are expected to be 50% of revenue. Fixed costs of production (excluding depreciation) are expected to be $2,500,000 p.a. Production equipment will be depreciated on a straight-line basis at 20% p.a. with no residual value expected. Table 3 - Economic and other data New Zealand company tax rate - 28% Assume tax in any year is payable in full at the end of that year. Assume that tax rebates can be off-set against other division profits and represent a cash inflow in the same year they occur. New Zealand inflation rate - 2.1% p.a. 30-day BKBM - 2.40% p.a. 5-year fixed-rate borrowing rate - 3.00% p.a. The risk-free rate is currently 2%p.a. Due to extreme uncertainty during COVID-19 the expected market return is currently around 11% Table 4 - Company Information The a2 Milk Company Limited July 2019 Balance Sheet Total current Property.plant and women Defend Totalt Total current abilities Trade and the Total non-cune Total Taityttable to one of the Company https://theaZmilikcompany.com/wp-content/uploads/The-az-Milk-Company_FY19-Annual Report doubles-1 Table 4 - Company Information cont. The a2 Milk Company Limited NZX Listing Information ATM $15.650 50040/0.264 Activity Performance Open Fundamental Volume https://www.nam.com/instruments/ATM The CFO of a2 usually prefers a payback period of less than 3 years on most new investments. Tasks: 1. Prepare a table showing the investment opportunity's cash flows over the five years. (10 marks) 2. Calculate the payback period for the investment project. (2 marks) 3. Determine a2's WACC that is applicable for use in a financial analysis. (4 marks) 4. Calculate the NPV and IRR of the investment project (4 marks) 5. Write a brief report to Craig Louttit, Chief Financial Officer of a2, summarising your findings and recommending whether or not the investment opportunity appears to be acceptable. (10 marks) CASE STUDY: The a2 Milk Company Limited In 2000 Dr Corran Mclachlan a research chemist from the Wairarapa and Howard Patterson an entrepreneur from Dunedin founded the A2 Corporation Limited to market milk, and milk products, that were free from the A1 (B-Casein) protein. The company had a difficult start with opposition from New Zealand's major milk-producing dairy cooperative (particularly over the health-claims made for the brand) but by 2003 it was able to launch its 2 and a2MILK brand products in New Zealand. Unfortunately during that year both Dr Mclachlan and Mr Patterson died and the company struggled financially and to help cash-flows the Company's Australian division was sold to a Singapore-based food and beverages conglomerate. The New Zealand division gradually grew both its product range and sales volumes and by 2006 was able to buy back the Australian division. A2 Corporations first profit announcement was made in 2011 and in March 2013 the company listed on the NZX. in April the following year it changed its name to The a2 Milk Company Limited and in March 2015 it dual listed on the ASX. The a2 Milk Company (2) currently operates in New Zealand, Australia and either in its own right or through joint ventures with local companies in China, the United States of America and the United Kingdom, a2 produces and markets not just A1 protein-free milk but a range of milk-based products such as whole milk powder, ice cream and yoghurt all manufactured using Al protein-free milk Through clever management of the release of its infant formula in China and after the announcement of an agreement with its previous opposition Fonterra, a2 shares leapt in value and by 2018 it had become New Zealand's largest (my market value) listed company The phenomenal growth that started in 2018 continued through 2019 with revenue and profits growing by 41% and 47% respectively and all markets, with the exception of the United Kingdom, demonstrating strong growth and high market penetration. In its 2019 Annual Report ax's Board Chair, David Hear stated: "The company enjoys a robust balance sheet which, combined with its continued strong cash generation, gives us the flexibility to support our growth potential in the future. The Board and management continue to evaluate a broad range of investment options designed to support our future growth aspirations. As a consequence, we do not anticipate paying dividends in the near-term The Investment Opportunity After your postgraduate study at the University of Auckland you were employed by a2 in its finance division. Your division works closely with the product development and marketing divisions and you have been working with colleagues from these areas on a new idea that reflects a2's objectives, as outlined by the chairman Research in the product development division has shown that a yoghurt product derived from the company's premium infant formula a2 Platinum is particularly beneficial in geriatric nutrition. Your marketing colleague believes that with appropriate promotion of these nutritional benefits such a product is likely to do exceptionally well, particularly in the US and China where the aging population represents an immense, untapped marketplace. She has asked you to produce a financial analysis that will support a proposal to the board to proceed with introduction of the new product to market. You have gathered the following detail to assist in your analysis The Investment Opportunity After your postgraduate study at the University of Auckland you were employed by a2 in its finance division. Your division works closely with the product development and marketing divisions and you have been working with colleagues from these areas on a new idea that reflects a2's objectives, as outlined by the chairman Research in the product development division has shown that a yoghurt product derived from the company's premium infant formula a2 Platinum is particularly beneficial in geriatric nutrition. Your marketing colleague believes that with appropriate promotion of these nutritional benefits such a product is likely to do exceptionally well, particularly in the US and China where the aging population represents an immense, untapped marketplace. She has asked you to produce a financial analysis that will support a proposal to the board to proceed with introduction of the new product to market. You have gathered the following detail to assist in your analysis: Financial Information Tables: Table 1 - Product Market Estimates Immediate total potential worldwide market for product is NZ$800 million revenue (equivalent) Total worldwide market is expected to grow by 5% annually Projected a world-wide market share is expected to be 3% in the first year of operation and increasing by 1% annually (i.e.4% of world-wide market in Y, 5% in Y, etc.) Table 2 - Marketing and Production Estimates Estimated life of investment - 5 years (the assumption is that by the end of this period new products will be available that will supersede the geriatric yoghurt product and production will cease). The initial investment in production facilities is expected to be $40,000,000 Marketing expenditure will commence immediately with a $10,000,000 investment in worldwide advertising and product awareness education (assume this all occurs in Y.) followed by four years of reducing marketing expenditure at the end of each subsequent year i.e. $7,000,000 in Yx: $5,000,000 in Y;$3,000,000 in Y and $1,000,000 in Ys. Sales revenue is expected to be $2.00 per item. Variable production costs are expected to be 50% of revenue. Fixed costs of production (excluding depreciation) are expected to be $2,500,000 p.a. Production equipment will be depreciated on a straight-line basis at 20% p.a. with no residual value expected. Table 3 - Economic and other data New Zealand company tax rate - 28% Assume tax in any year is payable in full at the end of that year. Assume that tax rebates can be off-set against other division profits and represent a cash inflow in the same year they occur. New Zealand inflation rate - 2.1% p.a. 30-day BKBM - 2.40% p.a. 5-year fixed-rate borrowing rate - 3.00% p.a. The risk-free rate is currently 2%p.a. Due to extreme uncertainty during COVID-19 the expected market return is currently around 11% Table 4 - Company Information The a2 Milk Company Limited July 2019 Balance Sheet Total current Property.plant and women Defend Totalt Total current abilities Trade and the Total non-cune Total Taityttable to one of the Company https://theaZmilikcompany.com/wp-content/uploads/The-az-Milk-Company_FY19-Annual Report doubles-1 Table 4 - Company Information cont. The a2 Milk Company Limited NZX Listing Information ATM $15.650 50040/0.264 Activity Performance Open Fundamental Volume https://www.nam.com/instruments/ATM The CFO of a2 usually prefers a payback period of less than 3 years on most new investments. Tasks: 1. Prepare a table showing the investment opportunity's cash flows over the five years. (10 marks) 2. Calculate the payback period for the investment project. (2 marks) 3. Determine a2's WACC that is applicable for use in a financial analysis. (4 marks) 4. Calculate the NPV and IRR of the investment project (4 marks) 5. Write a brief report to Craig Louttit, Chief Financial Officer of a2, summarising your findings and recommending whether or not the investment opportunity appears to be acceptable. (10 marks)