25300: Fundamentals of Business Finance - Angel Seafood Limited - Finance Assessment Answer

Subject Code: 25300

Finance Assessment Answer

Assignment Task: 25300 1. Angel Seafood Limited (hereafter known as "Angel") ordinary shares are listed on the Australian Securities Exchange (ASX) following an Initial Public Offering (IPO) in 2018. Angel is a South Australian-based producer of organically certified premium oysters. Since the IPO Angel has acquired substantial parcels of water leases in which they plan to grow high-quality export oysters. However, the unexpectedly high demand for its oysters has prompted Angel to consider upgrading to a larger oyster boat for its oyster beds located at its main facility at Coffin Bay in South Australia. According to the ASX announcement with the Date: 15/04/2019 and Headline: ‘Appendix 4C - quarterly' [The Announcement], Angel’s 10.75 hectares of waters at Coffin Bay are stocked with substantial numbers of pristine, high- quality oysters. Upgrading the boat will allow a more efficient oyster-harvesting process and more quickly reach positive cash flows. However, the cost of replacing the old boat with a new boat, the increased operating costs and additional capital expenditure in oyster dredges is substantial. Therefore, before Angel decides to upgrade the boat a financial analysis that considers the costs and benefits must be performed to determine if it will contribute to increasing the wealth of Angel shareholders. 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. 2. You are employed in Angel's 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. You recall how exciting it was learning about publicly-listed companies by searching and reading company announcements made to the Australian Securities Exchange (ASX) have complained that the current boat is outdated and too small and said to the Chief Financial Officer (CFO), “You’re gonna need a bigger boat”. The CFO has asked you to perform a financial analysis of the new boat using a purpose-built preformatted EXCEL spreadsheet. You will also search through public documents to identify some of the assumptions that will be required in your financial analysis. Your analysis will be provided to the Board of Directors who will formally decide whether to proceed with the new boat, based largely on your recommendation. 3. After spending $73,000 researching a range of oyster boats, Angel has identified one particular new 24-metre long oyster boat that costs $2,800,000. Angel plans to name the new vessel the Angel 7, continuing the numbering sequence used on its other vessels (See Figure 3 of The Announcement). The Angel 7 would also require the fitting of $300,000 worth of oyster dredges before entering operations. The directors are accountable to the shareholders and so a rigorous financial analysis is necessary to be confident that the large capital investment in the Angel 7 is justified. 4. The Angel 7 is extremely fuel efficient and has an annual fuel expense of $60,000 compared to the existing, smaller boat’s annual fuel expense of $75,000. Insurance of the existing boat costs $55,000 per year. To ensure the Angel 7 also costs $55,000 p.a. Angel’s insurance premiums are paid in cash at the end of each year. 5.Upgrading to the Angel 7 will allow Angel to harvest a greater number of oysters and lead to additional cash sales. The extra sales equal the number of oysters sold multiplied by the price per oyster. You calculate each of these two figures as follows: Quantity of Oysters 1. The Announcement states that Angel’s water leases currently contain approximately 20 million oysters. The existing boat can harvest 800,000 oysters each year and this figure is expected to remain unchanged. 2. A key motivation to upgrade the boat is that it will enable Angel to increase its annual harvest to an expected two million oysters in 2020. Thereafter, you assume the harvest quantity increases at 5% p.a. for the life of the new boat. Price per Oyster 1. You refer to The Announcement to calculate an average price per oyster. The estimated price per oyster for 2019 is equal to the stated sales for the quarter divided by the stated number of oysters. 2. Due to increasing demand for Angel’s organically-certified oysters, the price per oyster in 2020 is forecast to be 6% higher than the 2019 price per oyster. After 2020 Angel expects to achieve a constant 3% p.a. increase in the oyster price for the foreseeable future. 6. It costs $400,000 a year to operate Angel's brand new headquarters in Port Lincoln. With careful management, Angel believes they will not require any additional personnel in its head office if they purchase the Angel 7. In any case, the annual head office operating expense will increase by 2% each year. 7. According to The Announcement, Angel increased its NAB debt facility by $1.2 million. NAB is aware that Angel currently has negative operating cash flows but is not concerned as it has sufficient asset security, and confidence in Angel's management and ability to substantially improve future financial performance. Angel will use the additional $1.2 million to finance the Angel 7 on an interest-only repayment basis at 5% p.a. Angel will repay the $1.2 million in ten years’ time from its anticipated positive operating cash flows. 8. Labour represents the majority of Angel's total operating expenses. Currently, Angel's employee expenses are $1.2 million p.a. and are expected to remain constant for the next ten years. In Angel 7’s first year of operation, Angel’s total employee expenses are forecast to be $1.3m. With tight cost control, Angel believes they can restrict the increase in employee expenses associated with the new boat to $120,000 for the following year, and it will remain at this level for the remainder of the project. 9. Angel will evaluate the viability of the Angel 7 over a ten-year timeframe. All vessels operating in Australian waters require a maritime Certificate of Survey. New vessels are automatically certified at zero cost. However, the Certificate of Survey is valid for two years at which time it must be renewed at a cost of $40,000. Certification is an allowable tax deduction. If the Angel 7 were sold, it must have a valid Certificate of Survey. 10. To better reflect the long-term benefits of the $73,000 spent researching new boats, management suggests the expense be spread equally over the new boat’s ten-year evaluation period. This strategy will minimise the impact on Angel’s profitability for 2019. 11. The current oyster boat can be sold for $85,000 today. It was purchased in 2006 for $600,000 and it is being depreciated over a 20-year tax life. If Angel does not purchase the Angel 7 they will continue to operate the current boat. 12. One purpose of Angel’s IPO was to strengthen its balance sheet. Therefore, Angel now has $370,000 cash available on their balance sheet that it will use to partly fund the new vessel, which will substantially reduce the amount they need to borrow. Annual costs associated with Angel’s ASX listing are $121,000 and will remain constant for five years, increasing to $142,000 from year six onwards. 13. Pacific Oyster Mortality Syndrome (POMS) is a disease that affects Pacific oysters. A recent outbreak in Tasmania killed a large proportion of the oyster population and Angel is keen to avoid a POMS outbreak in its South Australian operations. To help prevent spreading the disease the Angel 7 will need $50,000 of antifouling paint to be applied each year as a preventative measure to reduce the growth of marine pests attached to the boat’s hull. This paint must be applied before the vessel is used, and then reapplied in each subsequent year. 14. According to the Australian Taxation Office (ATO) publication TR 2018/4 Income Tax: Effective life of Depreciating Assets, the Angel 7 is defined as a ‘Fishing Vessel’ with an effective life of twenty years. Angel 7 has an estimated value of $1,600,000 after ten years and just $240,000 in twenty years' time. The ATO determines that oyster dredges have a fifteen-year life for taxation purposes. Due to excessive wear and tear, oyster dredges have no value in the secondary market. For management reporting purposes Angel's policy is to depreciate all assets to zero using a five-year life. ATO policy is that all non-current assets are depreciated to zero. 15. In 2018, Angel invested $400,000 on a new wharf for its oyster boat fleet. The wharf has an effective tax life of thirty years and will be retained irrespective of whether Angel upgrades to the Angel 7 or not. 16. If the directors approve the new boat Angel anticipates that its current inventory of $4.5 million will increase by $2 million. In addition, accounts receivables will increase from $4.3 million to $5 million. There is some debate regarding whether these amounts should be included in the final year of the analysis. Currently, accounts payable are $1.8 million and you expect that this figure will not change if Angel purchases the Angel 7 vessel. 17. Assume the company tax rate is 30% and the required return is 12%. REQUIREMENTS Your team must answer the following 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 upgrading to the Angel 7. Annual figures for the oyster price and the additional quantity of oysters harvested with the Angel 7 must be supplied in the designated cells. Questions 5 to 8 require you to answer additional questions that will demonstrate to the CFO your level of financial understanding. 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 new boat, and your recommendation to the Board? 25300 FBF – AUTUMN 2019 Group Assignment Page 3Additional Financial Information (6 Marks) 5. According to Angel's Corporate Governance Manual, which of the SPECIFIC RESPONSIBILITIES OF THE BOARD would best relate to the decision to purchase the Angel 7? (Note the corresponding letter from 'a)' to)'). 6. Angel is planning to purchase an additional two hectares of water holdings on 28 May 2019. Angel plans to pay for the water rights by making a series of $15,000 payments every three months to the seller. The first $15,000 payment occurs on 28 May 2020 and the final $15,000 payment occurs on 28 May 2022. Assuming interest rates are 6% p.a. compounded quarterly, what is the equivalent value of the water rights on 28 May 2019? 7. Page 1 of The Announcement explains that cash receipts from customers are $923,000 for the first three months of 2019. What might explain why this figure is substantially higher than the stated sales for the same time period? 8. Equity analysts predict Angel will pay its first annual dividend of $0.02 in 2021. The dividend in 2022 is expected to be 25% larger than the 2021 dividend as the company’s cash flows grow substantially. Beyond 2022 the dividend is expected to increase by 4% p.a. forever. If the required return is 12%, then what is the fair value of an Angel share today, in 2019?

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