BAFI 3257 - Corporate Financial Management ASSESSMENT TASK 2
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BAFI 3257 - Corporate Financial Management
ASSESSMENT TASK 2 – GROUP ASSIGNMENT
Semester 2 – 2022
Objective
In this assignment, students are required to prepare a detailed business report based on a case study. The case study describes actual business situations faced by financial managers and focuses on the application of concepts such as capital budgeting, capital structure and other related topics covered in the course.
The objective of this assignment is to give students the opportunity to:
• work constructively and effectively in a team,
• develop the ability to analyse investment opportunities, estimate the appropriate cost of capital, and evaluate a firm’s choice of capital structure,
• develop effective written communication skills,
• develop work-ready skills using Refinitiv Eikon database, one of the most
comprehensive databases that is widely used by industry practitioners. Details about the case study and its requirements are set out below.
Scenarios
It is 1st July 2022.
Your team of three people form a financial analysis team at Aussie Finance Consulting (AFC), a renowned financial institution. The executive management of AFC has assigned you a task to carry out a special project for its client Wesfarmers Limited (WES), which requires preparing a business report. This report will be presented to AFC executive management and the senior management of WES.
Wesfarmers Limited is an Australia-based company, which is engaged in various business operations, such as home improvement and outdoor living; apparel and general merchandise; office supplies; health, beauty and wellbeing; chemicals, energy and fertilizers, and industrial and safety products. Its segments include Bunnings; Kmart Group; Officeworks; Wesfarmers Chemicals, Energy and Fertilisers (WesCEF); Industrial and Safety; and Other. The Bunnings segment is a retailer of home improvement and outdoor living products in Australia and New Zealand. The Kmart Group segment comprises Kmart, Target and Catch and operates about 462 stores across Australia and New Zealand. The Officeworks segment is a retailer and supplier of office products and solutions for small and medium-size businesses, students, and households. The WesCEF segment manages a portfolio of sustainable businesses. The Industrial and Safety segment is a supplier of industrial, safety and workwear products, and services.
Requirements
You are required to advise the company on the following:
Part 1. Estimate WES’s Weighted Average Cost of Capital (WACC). (15 marks)
(a) Estimate the firm’s cost of debt using two different methods. How do your results compare?
- Assume that the company’s policy is to use the expected return on its domestic bonds as its cost of debt.
- The company’s bond ratings, risk-free rate and market risk premium can be obtained from Eikon (use Eikon’s ERP application for the latter). Information about historical average default rates by debt rating, average debt betas by rating and maturing, and average loss rate by debt seniority are given in the Rating.pdf file.
(b) Calculate market value of the firm’s long-term debt.
- Assume that the only long-term debt the firm has are coupon bonds (issued at @100 each) with the current price at $83 each. Use the reported amount of Total Long Term Debt in the Balance Sheet for the latest fiscal year as the book value (par value) of the bonds.
(c) Implement CAPM to estimate the company’s stock beta and cost of equity capital.
- Collect data on monthly closing share prices, market return, and risk-free rate from 1 July 2017 to 1 July 2022. Use this data to estimate raw beta by using regression analysis, then adjust the raw beta using the formula:
Adjusted Beta = × Raw Beta +
- Use the 10-year Australian Government bond yield as a proxy for the risk-free rate. This yield can be found on Eikon page AU10YT=RR. Take the current Bid yield (do not use the bond price).
(d) Estimate the firm’s WACC. How confident are you of your WACC estimate? Discuss, if any, implicit assumptions you make in your estimation.
- Assume that the firm’s tax rate is 30%.
Part 2. Analyse the project described below and make recommendations to WES
whether they should undertake the project. (30 marks)
The company is now considering developing new own-brand products. Development of the new products will initially require an initial capital expenditure equal to 6% of WES ’s Property, Plant, and Equipment (PPE) at the end of the latest fiscal year for which data is available. The project will then require an additional investment equal to 10% of the initial investment after the first year of the project, a 5% increase after the second year, and a 1% increase after the third, fourth, and fifth years. Assume that WES will fully depreciate these assets by the straight-line method over a seven-year life. At the end of the project, these assets can be sold for about 30 percent of its acquisition values. The project requires an initial investment into net working capital equal to 8% of predicted first-year sales. Subsequently, net working capital is 5% of the predicted sales over the following year.
The company has recently completed a $500,000 two-year market study to judge the likely popularity of the new products. WES ’s management is uncertain whether to charge this $500,000 market study to the project. Based on the results of the study, they have estimated that the products are expected to have a life of five years. First-year revenues for the new products are expected to be 3% of WES’s total revenue for the latest fiscal year for which data is available. The new product’s revenues are expected to grow at 10% for the second year then 7% for the third and 3% annually for the final two years of the expected life of the project. Assume that the project’s EBITDA margin will be similar to WES’s existing projects in the latest fiscal year.
WES’s accounting information can be obtained from Eikon.
(a) Estimate the investment outlay of the project.
(b) Estimate the annual after-tax operating cash flow.
(c) Estimate the terminal-year net cash flow.
(d) Calculate the NPV of the project. Your team decides to use the WES ’s WACC computed in Part 1 as the required rate of return for the project. Which implicit assumptions do you need to make for this use?
(e) Advise if the project should be undertaken.
Part 3. Perform risk analyses for the project. (20 marks)
Your team has identified several key aspects for the project. The following table shows assumptions of the best and worst cases.
Parameter |
Worst Case |
Best case |
First-year sales (as a percentage of the total revenues in the latest fiscal year) |
3% |
7% |
Revenue growth rate |
Constant after the first year at a rate of 0% |
Constant after the first year at a rate of 15% |
Project’s EBITDA margin |
-5% to the initial assumption |
+5% to the initial assumption |
Initial investment in Net Working Capital |
6% of the first year’s sales |
10% of the first year’s sales |
Beta |
The upper bound of 95% confidence interval |
The lower bound of the 95% confidence interval |
(a) Perform break-even analysis with respect to the first-year sales parameter.
(b) Perform sensitivity analysis for each parameter. Evaluate which parameter is the most important to the project.
Part 4. Analyse WES capital structure and recommend WES on their capital structure
decision. (30 marks)
In the next phase, WES aims at expanding the business globally. The company needs to raise more capital for the purpose. However, the executives worry about the level of debt in the current capital structure and are debating if they should raise sufficient money through common stock only.
(a) Identify the business sector the firm operates in, observe debt ratios of firms operating in this sector over the last five years, and determine whether WES is under or over leveraged relative to the firm’s competitors and the sector average.
(b) Estimate WES’s business risk and how it compares with the competitors and the sector average. Note that a firm’s business risk can be measured as the standard deviation of its over the last five years.
(c) Recommend whether WES should use more debt to finance their future expansions and explain why. Consider advantages and disadvantages of debt financing in the discussion.
Part 5. Business Report Overall Quality (5 marks)
The assignment is to be presented as a business report to both AFC and WES executive management. This report needs:
• Page numbering
• Informative heading and sub-headings
• Numbered sections
• Executive summary
• Introduction & Conclusion
• Table of contents
• Reference list
Your report is to be submitted as a PDF version of your work.
The report must use a font/fonts suitable for business communication.
The reference style to be used is Harvard style referencing. RMIT guide to referencing can be found viahttps://www.lib.rmit.edu.au/easy-cite/.
Your main report will have a maximum of 3,500 words, excluding appendix, and will be professionally presented. A concise, relevant and visually appealing report is essential for business communication.
General Instructions
Essential Contents:
Your report needs to set out the following at its least:
• An executive summary
• A table(s) showing the calculations of WACC using market data / CAPM
• A table(s) showing the NPV analysis
• A selection of NPV spreadsheets used in the risk analyses
• A recommendation to WES ’s management whether they should develop the new product.
• Calculation of debt ratios and business risk
• Discussion about SLC’s capital structure
• A list of references
• Appropriate appendices.
How to Write an Executive Summary
An executive summary is often written for leaders in a business or organisation, such as CEOs, department heads, or supervisors, so they can get critical information quickly to decide a course of action. An executive summary should summarise the key points of the report. It should restate the purpose of the report, highlight the major points of the report, and describe any results, conclusions, or recommendations from the report. It should include enough information so the reader can understand what is discussed in the full report, without having to read it. Do not state your methodology in the Executive Summary.
Guidelines
Regarding the calculations, whilst you need to present your final work in tables in the main body of your report, all subsidiary calculations need to be provided in an appendix. You need to provide detailed steps (e.g. formulae) that lead to the final answers. Correct final answers alone will not earn full marks. Also, annotate your appendix so that the examiners can understand your work.
Refer to the lecture slides and workshop questions for the topics - Capital Budgeting, Asset Valuation, and Cost of Capital and to present your calculations.
Please round off your values to 4 decimal places for interest rates and two decimal places for amounts, e.g. 0.0659 or 6.59%, and $10,369.78
All assessment of numerical work is marked consequentially. So, you will be awarded marks for all correct calculations and procedures.
Marking Rubric
Marking rubrics are provided on Canvas.
2022-09-04