- 25300 Fundamentals of Business Finance Autumn 2016
Due by 9am Monday 30 May 2016
(Answers to be submitted using the Assignments feature of UTSOnline)
Contributes 20% of your total assessment
1. Costa Group Holdings Limited (hereafter known as “Costa”) ordinary shares are listed on the Australian Securities Exchange following an Initial Public Offering (IPO) in 2015. Costa is a supplier of fresh fruit and vegetables to the major supermarket chains. Their brands include Driscoll’s berries and Blush tomatoes. Costa used part of the IPO proceeds invest in growth opportunities such as a new tomato glasshouse in the NSW regional city of Guyra. This glasshouse became operational in 2015 however, as stated in the investor presentation released to the ASX on 25/02/2016 it is already “operating at capacity”. Costa’s Growth Plan states that they are considering constructing another tomato glasshouse. Growing tomatoes in a glasshouse offers substantial advantages compared to field-grown tomatoes. Key benefits include the ability to grow tomatoes for 52 weeks of the year, crop protection from adverse weather events and temperature control. For these reasons the yield per hectare for glasshouse-grown tomatoes is ten times that for field-grown tomatoes. However, costs associated with the construction of a glasshouse and the annual operating expenses are substantial. Therefore, before Costa decides to invest in a new glasshouse a financial analysis that considers the costs and benefits must be performed to determine if it will contribute to increasing the wealth of Costa shareholders.
2. You are employed in Costa’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 listed companies by searching and reading company announcements made to the Australian Securities Exchange (ASX). The Chief Financial Officer (CFO) has asked you to perform a financial analysis of the tomato glasshouse using a purpose-built preformatted EXCEL spreadsheet. The CFO has suggested you liaise with company employees from a variety of different departments to collect the information that is necessary to perform the analysis. 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 glasshouse, based largely on your recommendation.
3. The two major expenses associated with constructing a brand new glasshouse are $3 million for site preparation (i.e., excavation and grading) and the capital expenditure of $22 million for the glasshouse structure (excluding irrigation, as explained in paragraph 11). The directors are accountable to the shareholders and so a rigorous financial analysis is necessary to be confident that the investment in the new tomato glasshouse is justified. 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.
4. Costa announced on 25/02/16 that it will pay an interim dividend of 3 cents per share. The number of shares “at reporting date” is stated in Note 9 to the half-year accounts.
5. Costa owns a 50-hectare parcel of land on which they plan to construct the new glasshouse. This land is currently leased to a third party for $1.3m each year and the leaseholder is prepared to continue the lease indefinitely. The new tomato glasshouse has been developed by Costa’s Research and Commercialisation centre. Over the last four years this centre has spent $5 million researching and designing the new tomato glasshouse. As section A.8 of the IPO states, “Expenditure on research activity is recognised as an expense when incurred”. There is some debate among management about whether the research expenditure should be treated as an opportunity cost in the analysis to ensure that this money earns an appropriate return or simply classified as an expense.
6. The annual cash sales of tomatoes associated with the new glasshouse depend on the forecasted tomato price and the projected harvest quantity. Therefore, your first job is to determine estimates of these two variables using the following information:
Forecasted Tomato Price x You first estimate the tomato price per tonne in 2016 by dividing the sales value of tomatoes in 2016 by the volume (in tonnes) harvested. x The sales value of tomatoes is not given but Section 3.4 of the prospectus states the percentage of 2016 Produce Revenue contributed by tomatoes. x You also search the prospectus and locate the FY2016 produce revenue figure (Note:
You will need the Pro Forma financial information reported by segment). x Costa anticipates harvesting 17,360 tonnes of tomatoes in 2016. x Using the 2016 tomato sales value figure and the 2016 harvest quantity you can then infer the sales price per tonne in 2016. Costa assumes that this price is also the 2016 sales price per tonne for tomatoes grown in the new glasshouse. x Due to competition and supermarket buyers constantly bargaining for lower prices, Costa assumes that the 2016 tomato price per tonne will then experience price deflation of 2% each year, starting in 2017.
x Sales from Costa’s existing tomato glasshouse are predicted to increase by $1.9m each year compared to the FY2016 figure regardless of whether the new glasshouse is built or not.
Projected Harvest Quantity
x Costa predicts that the new glasshouse will produce 2,500 tonnes of tomatoes in 2017 (i.e., its first year of production). Costa has confidence that the strong historical growth rates in glasshouse-grown tomato volumes will continue in the future. The 2017 harvest volume is predicted to increase by 12% in 2018, 2019 and 2020, and then maintain an annual growth rate of 4% for the remainder of the life of the glasshouse.
7. It costs $3.7 million a year to operate Costa’s Victorian headquarters. With careful management Costa believes they will not require any additional personnel in headquarters if they build the new glasshouse. In any case, the annual headquarters operating expense will increase by just 2% each year.
8. Because glasshouse-grown tomatoes are hand-picked and hand-packed, labour represents the vast majority of Costa’s total operating expenses. Employee expenses related to the existing glasshouse are $9.2 million per annum and are expected to remain constant for the next ten years. Employee expenses for the new glasshouse are forecast to be $5.3m in its first year of operation. With tight cost control Costa believes they can restrict the annual increase in employee expenses associated with the new glasshouse to $800,000 for each subsequent year.
9. Pest control in the new tomato glasshouse can be performed using the existing underutilised equipment in the current glasshouse. The equipment has an annual operating cost of $770,000 per annum, regardless of how much it is used. The accounts department suggests allocating fifty percent of the annual operating cost to the new glasshouse.
10. Costa will evaluate the viability