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7BSP1276: International Finance For Global Business - Organic Farm Foods - Case Study Assignment Help
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Any new venture would be expected to achieve a return on capital employed in line with that experienced recently by Organic Farm Foods plc and the finance director favours a payback period of 5 years.
The favoured project under consideration involves extending the farming element of the business by purchasing 1000 acres of good farm land in the Republic of Ireland. At €8,088 per acre, land in the Republic of Ireland is less expensive than in Buckinghamshire giving OFF plc a cost advantage over their existing farm production. It is timely that a 1000 acre farm has become available in County Kildare as the current owner wishes to retire. The price of €8,088 per acre includes all of the farm buildings but an additional investment of €1.21m will be required for agricultural machinery. It is company policy to depreciate machinery at 10% per annum on a straight line basis.
The finance director has provided estimated income and cost forecasts (under normal weather conditions) for the first ten years of the project. The projected figures are, like the UK Company’s, subject to alteration if weather conditions vary. Sales are expected to be €968(k) in 2020 and grow at 20% per annum to 2029. Total variable costs (of which 40% is labour cost) are expected to be €395(k) in 2020. Both labour costs and other variable costs will increase by 3% per annum. There will also be fixed costs of €130(k) in 2020 which will increase by 2% per annum.
The British government is currently negotiating new trade arrangements with the European Union and a number of other countries and the performance of Organic Farm Foods will depend on the outcome of those negotiations. If the UK government is able to obtain favourable trading terms then the net cash flows from the project will be 15% higher than under the base case scenario. The probability of this outcome is put at 30%. There is, though, a small chance (15%) that trade terms will be unfavourable resulting in net cash flows being 30% less than base case cash flows.
The beta of Organic Farm Foods plc is believed to be 1.45. The rate of return on 10yr UK government bonds is 1.32% and the FTSE all-share index return for the last year is 5.3%. The corporation tax rate in the Republic of Ireland is 12.5% and UK corporation tax is currently 19%. Both are payable at the end of the accounting year in question (you may assume for the purpose of this case that accounting profit and taxable profit are identical). The current rate of exchange is £1 = €1.21.
There would be no restriction on the transfer of profits/cash flows to the UK. It is considered possible that, as the Irish economy develops further, even higher wages than forecast may be demanded by the workforce.
Task:
Evaluate the Irish investment project on behalf of Organic Farm Foods plc and advise the firm on whether the project is viable on a financial basis. Also, advise the firm on the potential impact of foreign exchange risk on the project and evaluate the alternatives for financing the project.
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Case : Organic Farm Foods plc (t0 = 2019) Organic Farm Foods (OFF) was founded in the 1980’s when the Greystone family acquired an arable farm in Buckinghamshire. Demand for their wholesome organic food was brisk and the business expanded rapidly in the 1980's but remained a family business. It was restructured as a limited company in 1990 and subsequently experienced rapid growth until 2000. In that year the then directors decided that the business had reached the limit of development in its present form. Future development required large-scale expansion in order to compete with the cost base of non-organic food producers, which in turn needed an injection of capital that the Greystone family were unable to generate themselves The conviction that there was much money to be made from “quality organic foods" had been vindicated but the directors felt that it would be safer to look for other avenues for future development. They investigated a number of possibilities deciding eventually to expand production facilities and establish their own packing/distribution system so that their newly 'branded' produce could be sold by independent quality food retailers. Upon raising the necessary capital in the name of Organic Farm Foods plc, they embarked upon a, to date, successful venture. As the market grew and to keep abreast of new production technology, the directors agreed to further update the plant and machinery. They financed updating of equipment and premises by means of issuing debentures. It is now September 2018 and the present directors of Organic Farm Foods plc believe that the long-term success of the company lays in future diversification and expansion and a number of new projects are under consideration. The newly appointed finance director, Stephen Sterling, agrees with this opinion but insists that the company must first appraise its own current position and, if necessary, make changes to strengthen its existing financial situation before embarking on new plans. He is particularly concerned that the company should preserve adequate liquidity and finance its assets in a beneficial manner. Members of the Greystone family still retain 30% of Organic Farm Foods equity and other long-standing directors own a further 25%. A change of control is unlikely to be welcome. During the last year, the company has updated production and distribution assets and, in what has been a difficult year, has been able to maintain sales and profit growth (see OFF plc accounts in Appendix 1). There has been a great deal of uncertainty about world economic growth and stock markets have been extremely volatile resulting in the firm’s ordinary shares trading below their level of one year ago although the preference shares have made some progress, increasing by 20p during the year. Ordinary share dividends have achieved an average growth rate of 5% per annum over the past five years and this rate is expected to be maintained in the future. The present market prices for Organic Farm Foods plc shares and debentures are:
Any new venture would be expected to achieve a return on capital employed in line with that experienced recently by Organic Farm Foods plc and the finance director favours a payback period of 5 years.
The favoured project under consideration involves extending the farming element of the business by purchasing 1000 acres of good farm land in the Republic of Ireland. At €8,088 per acre, land in the Republic of Ireland is less expensive than in Buckinghamshire giving OFF plc a cost advantage over their existing farm production. It is timely that a 1000 acre farm has become available in County Kildare as the current owner wishes to retire. The price of €8,088 per acre includes all of the farm buildings but an additional investment of €1.21m will be required for agricultural machinery. It is company policy to depreciate machinery at 10% per annum on a straight line basis.
The finance director has provided estimated income and cost forecasts (under normal weather conditions) for the first ten years of the project. The projected figures are, like the UK Company’s, subject to alteration if weather conditions vary. Sales are expected to be €968(k) in 2020 and grow at 20% per annum to 2029. Total variable costs (of which 40% is labour cost) are expected to be €395(k) in 2020. Both labour costs and other variable costs will increase by 3% per annum. There will also be fixed costs of €130(k) in 2020 which will increase by 2% per annum.
The British government is currently negotiating new trade arrangements with the European Union and a number of other countries and the performance of Organic Farm Foods will depend on the outcome of those negotiations. If the UK government is able to obtain favourable trading terms then the net cash flows from the project will be 15% higher than under the base case scenario. The probability of this outcome is put at 30%. There is, though, a small chance (15%) that trade terms will be unfavourable resulting in net cash flows being 30% less than base case cash flows.
The beta of Organic Farm Foods plc is believed to be 1.45. The rate of return on 10yr UK government bonds is 1.32% and the FTSE all-share index return for the last year is 5.3%. The corporation tax rate in the Republic of Ireland is 12.5% and UK corporation tax is currently 19%. Both are payable at the end of the accounting year in question (you may assume for the purpose of this case that accounting profit and taxable profit are identical). The current rate of exchange is £1 = €1.21.
There would be no restriction on the transfer of profits/cash flows to the UK. It is considered possible that, as the Irish economy develops further, even higher wages than forecast may be demanded by the workforce.
Task:
Evaluate the Irish investment project on behalf of Organic Farm Foods plc and advise the firm on whether the project is viable on a financial basis. Also, advise the firm on the potential impact of foreign exchange risk on the project and evaluate the alternatives for financing the project.
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