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That the possibility of product cannibalisation has not been considered; After-tax cash flows


Part A (40 Marks)

Saturn Petcare Australia and New Zealand is Australia’s largest manufacturer of pet care products. Saturn have been part of the Australian and New Zealand pet care landscape since opening their first manufacturing facility in Albury Wodonga in 1966. Since then they have expanded their manufacturing footprint to include other sites in regional Australia and New Zealand including a world-leading manufacturing site opened in Bathurst, NSW in 2015. Saturn Petcare Australia New Zealand manufactures both for the domestic markets as well as exporting products to more than 26 countries. Saturn Petcare is part of the larger overall Saturn Group which is globally one of the largest privately held manufacturing companies and operates in a range of different fast moving consumer goods (FMCG) sectors including manufacturing well-known chocolate, confectionary, and food brands as well as pet food and pet care products.

Saturn have undertaken externally commissioned market research at a cost of $250,000 which has identified that a market exists for a new premium dog snack to be manufactured under their ‘Optimal’ premium pet food label. The Saturn marketing department have estimated that the new product will achieve sales of AUD$30 million in the first year and that sales will be expected to increase by 10% pa year on year for at least 10 years.

If Saturn proceed with this product launch a manufacturing production line must be constructed at an estimated cost of $27.5 million. To house the new production line Saturn have the opportunity to construct a purpose built facility alongside its existing dry food factory in Bathurst for a cost of $8 million. Alternatively, the production line could be built within an existing vacant factory space at the Wodonga head office site. When operational the new production facility is expected to create full time employment for an additional 20 staff. In addition you are advised that the Bathurst City Council has decided to offer as an incentive if the new facility is built in Bathurst a 100% rebate of the council municipal rate on Saturn’s Bathurst site (valued at $500,000 per year). In addition, the Bathurst City Council has negotiated a one-off regional infrastructure grant from the NSW state government of $2.5 million payable when construction of the facility commences. The existing factory space where the plant is planned to in Wodonga, Victoria is unused and there is no opportunity cost associated with it. It is expected that the production line plant and equipment will be depreciated on a straight line basis over its expected useful life of 10 years. The new building in Bathurst will have a useful life of 25 years and will be depreciated on a straight line basis. Saturn are an international company and pay Australian tax at the rate of 30% on profits. The capital budgeting analysis should be conducted on an after tax basis.
You have been asked by Nathan Quinlivan the Demand and Strategy Finance director for Saturn Petcare Australia New Zealand to conduct a capital budgeting analysis of the two options. Saturn have a global target return on investment of 22% pa. Margin after Conversion (MAC) for this new product is budgeted at 30% of gross sales.
Nathan Quinlivan advises you that he is concerned about three issues:
  1. That the possibility of product cannibalisation has not been considered;
  2. Marketing estimates of year on year sales increases are high; and
  3. He believes that the original $6 million cost of the vacant Wodonga factory space should be considered in the analysis.
Required:
For both the Bathurst and Wodonga production options calculate the following:
  • After-tax cash flows (6 marks).
  • Payback periods (4 marks).
  • Net present values (6 marks).
  • Profitability index (4 marks).
     
What recommendation would you make regarding the projects? Discuss any further information that you may require to help you make the accept/reject decision about either of these projects (5 marks).
Define ‘product cannibalisation’ in capital budgeting decisions and address Nathan’s concerns that it should be considered (5 marks).
Address Nathan’s concerns that Saturn’s marketing department’s budgeted sales estimates may be too high. What capital budgeting options are available to compensate for such an error? (5 marks)
Address Nathan’s concerns that the original value of the vacant Wodonga factory should be included in the analysis (5 marks).
 
Part B (60 Marks) Report
Guidelines:
For this assignment, you are encouraged to use the information provided on the firm's corporate websites together with the following sources:
Your report should include:
  • A brief executive summary.
  • Introduction.
  • Body (use appropriate headings and sub-headings as relevant sign-posts).
  • Conclusion
     
Required:
ARB Corporation Limited designs, manufactures, distributes, and sells off road motor vehicle accessories and light metal engineering works in Australia, the United States, Thailand, the Middle East, and Europe. The company operates approximately 61 ARB stores in Australia. ARB Corporation Limited was founded in 1975 and is headquartered in Kilsyth, Australia. ARB is listed on the Australian Stock Exchange and reported total revenue for the 2017 financial year of almost $385 million.
As part of the finance team of ARB Corporation you have been tasked with reviewing and preparing a report on the capital structure of the firm and critique whether the firm has been successful in maximising wealth generation for shareholders.
Your report should be 1000 words and cover the following areas:
 
(i) Using data from the firm's 2017 financial year annual report and other sources assume that the firm ARB has a Beta of 0.89 (Reuters) and that capital return on the market for 2017 was 8.54%:
  • Categorise the firm's current capital structure into debt and equity.
  • Calculate the firm's after-tax Weighted Average Cost of Capital.
  • Using the CAPM calculate whether the firm is providing an appropriate return given its risk
(ii) Compare the firm's capital structure with at least one other firm operating within a similar industry.
(iii)  Critically analyse other key financial ratios for ARB.
(iv)  Outline any significant changes to have occurred to the firm's capital structure during the past three years.
(v)  Critically evaluate the extent to which the firm has been successful in maximising wealth for shareholders in the past three years. In doing so discuss why it is important for the firm to minimise their cost of capital.
(vi)  Recommend possible ways in which the firm could adopt an alternative capital structure and lower their cost of capital.


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