Reference no: EM132788059

7211AFE Corporate Finance - Griffith University

Case Study on Corporate Finance

Part A: Case study report for selected company

The purpose of this case study is to allow students to take some of the main concepts introduced in the course and provide a framework for applying them to a company of their choosing. One of the best ways of learning corporate finance is to apply the models and theories we encounter to the real-world contexts and problems. You will:
• Task 1: Evaluate the company corporate governance
• Task 2: Evaluate stock price, and estimate the impact of an important announcement on its stock prices;

Scenario

You have recently started an internship position with Griffith Best Equity Management (GEM), a large asset management company with A$750 million Assets Under Management located in Brisbane CBD. The company's core investment focuses on domestic share market, however, investments in share markets have provided lower than expected returns in the recent years.

GEM's Chief Investment Officer (CIO) has assigned you to perform an investment appraisal on a single company listed on the ASX200 and provide recommendation if the company analyzed should be included as part of GEM's investment.

Your personal values and experiences are important, you should base your response on the evidence provided in these tasks along with your knowledge gained in the course. It is important that you provide clear evidence of your ability to apply your knowledge of finance as learned in the course to the task. The CIO has requested that your analysis must be up-to-date analysis with at least 3 years of data.

Your report must address the following issues, the first four issues are related the corporate governance (task 1), and the fifth issue is related to the share price analysis (task 2):
1. A brief description of the company analyzed
2. Information of the CEO of the company
3. The Board of Directors of the company
4. Societal Constraints
5. Analysis of company's share price using
a) the Dividend Discount Model (1-stage and 2-stage). You will determine if the share price is priced fairly or over/under-valued (Hint: to apply the DDM model and multi-stage model, you may need to calculate the beta, and cost of equity for the firm first, for more details, please refer to the guidance for 4.a and 4.b).
b) News/Announcement effect on company's share price. You will investigate the speed of share price adjustment to these announcements using graphs. You will discuss the share performance over the last 3 years, showing the major events (announcements) in the life of the company and discuss how these events (announcements) have impacted the share price.
c) On the same chart, present the performance of the major competitor and the market for comparison.

Your current internship position is under 3 months' probation period. Upon completing the task on hand, your department secretary will arrange a meeting with CIO to discuss whether you have passed the probation period and be promoted to a Junior Corporate Finance Analyst.

Guidance for Part A
Task 1: Corporate Governance
1. A brief description of the company analyzed

2. The CEO
a) Who is the CEO of the company?
b) How much did the CEO make last year?
c) What form did the compensation take (salary, bonus, options)?
d) How much equity in the company does the CEO own?

3. The Board of Directors
a) Who are on the board of directors of the company?
b) How long have they served as directors?
c) What is their remuneration?
d) How many of the directors have other connections to the firm (as suppliers, clients, customers, etc.)? Are they independent?
e) How many of the directors are CEOs of other companies?
f) Do any of the directors have large stockholdings?

4. Societal Constraints
a) How the firm addresses the issue of Corporate Social Responsibility?
b) Does the firm have a particularly good or bad reputation as a corporate citizen?
c) If it does, how has it earned this reputation

Task 2: Evaluate stock price, and estimate the impact of an important announcement on its stock prices

5. Evaluate stock price, and estimate the impact of an important announcement on its stock prices

a) Stock beta: Download 3 years of weekly stock returns and ASX200 market index returns ending June 2020 from Yahoo Finance and estimate the stock beta. Does the estimate of stock beta make sense to you? (The normal range of beta is from 0.5 to 3.) Provide reasoning, why or why not? If not, you have to use the stock beta from Yahoo Finance for the later parts.

b) Estimate the Cost of equity, using the CAPM return. Assume the market risk premium, Rm- Rf=6%, and use the current 10-year Government bond yield for the risk-free rate.

c) DPS is the total annual dividend per share paid for the financial year. Based on the previous 5-year pattern of DPS payments, estimate the intrinsic values using 1-stage models (the constant dividend growth model), and the 2-stage non-constant dividend growth model. Please use the 10-year Government bond yield as the Dividend growth rate in the equilibrium stage. You need to choose which model is the most appropriate one to use, and compare the intrinsic value versus the share price as of November 2020 (‘current price'). Would you recommend to buy or sell the shares in November 2020?

d) You will study an announcement in 2018-2020 from this company from ASX 200 firms (https://www.asx200list.com/). The announcement can be a new product, a scandal, an earnings announcement, a change in strategy, etc. What is your expectation of the market reaction to the announcement, good or bad news?

On the same chart, present the performance of the major competitor and the market for comparison. Discuss the following aspects: Does the stock price react quickly or slowly to the news announcement? How does it relate to the theory we learned in class?

Choice of Company
You can choose any company from ASX200 (except for TPG) that has been listed on the stock exchange for at least 3 years, and with positive earnings and positive dividend for the 2019/2020 financial year.

A complete submission to Learning@GU/SafeAssign consists a Word file, an Excel file, and should include the following:
a. All input variables, such as risk-free rate, the market risk-premium, dividend growth rate, etc, and
b. all computations such as the beta estimate, cost of equity, intrinsic value, Analyst Expected Return, RRR, etc. Please put all input variables in an input box.
c. Font size: 12 of Calibri, Arial or Times New Roman
d. Margins: minimum 1 cm on the top/bottom and right/left.

Task #1: Multi-chem

You are a financial analyst in the capital projects department of Multi-chem, a speciality chemicals producer of fire-control chemicals, additives, and pesticides based in Queensland. Currently, Multi-chem is small in scale, but embarking on a rapid expansion and modernization program. It is also expanding its range of products into dyes, rubber compounds, and water treatment chemicals. While Multi-chem has a large and expanding capital budget, it is currently considering which of two possible projects it should invest in, both of which would be used to manufacture furfural (an organic compound derived from agricultural by-products) and furfural-based derivatives to make resins, urethanes, and refining solvents over a 10-year operating period.

Scenario
The first project, the Manila Plant, is a proposed new plant in the Philippines, about 30 km outside the capital. Multi-chem has been considering this expansion for a number of years and believes that the combination of low wages, looser environmental protection, and proximity to its emerging markets in SE Asia will makes this new plant an attractive addition to its existing facilities. Specifically, in 2020 the Manila Plant will require the purchase of land for $2.55 million, with development and construction building costs of $13 million, and plant and equipment of $6 million. Multi-chem will also need to spend on working capital each year. The change in net working capital is estimated to be 4% of sales every year during the life of the project (the exception being the last year of the project which reverses the sum of all previous cashflows due to working capital). Sales are estimated to be $48.6 million in 2021, the first year of production, increasing by 10% per annum after that. The cost of goods sold is 65% of sales. Fixed costs will be $11.5 million in 2021, increasing by 5% per year. Both buildings and plant/equipment will be depreciated straight line to zero over the 10-year project life. The buildings will have a salvage value of 20% of cost and the plant and equipment will have no salvage value. At the end of the project, Multi-chem will rehabilitate the site and sell the land for light industrial development for $18.1 million. The company tax rate in the Philippines is 25%.

The second project, the Townsville Plant, is a modification of an existing plant Multi-chem already owns in the city of the same name in north Queensland. The Townsville Plant has been idle for a number of years, but with renovation would be well suited to furfural production. If not used for the proposed project, Multi-chem will lease out the existing plant for $70,000 per year. The estimated development and construction building costs will be $15 million in 2020 alongside plant and equipment investment of $5 million. Multi-chem will again need to invest in working capital, thus the change in net working capital is estimated as 4% of sales every year (the exception being the last year of the project which reverses the sum of all previous cashflows due to working capital). Sales will be $45 million in 2021, increasing by 7% per annum thereafter. Given the relative geographic isolation of the plant and the stricter environmental controls given the proximity to the Great Barrier Reef, the cost of goods sold will be 75% of sales. Fixed costs will be $5 million in 2021, increasing by 5% per year. Both buildings and plant/equipment will again be depreciated straight line to zero over the 10-year project life. The buildings will have a salvage value of 30% of cost and the plant and equipment will have no salvage value. At the end of the project, the Townsville Plant will again revert to being idle awaiting potential future developments at no cost. The company tax rate in Australia is 30%.

Task
Provide a report to Multi-chem's CFO, Ms. Mary Miller, recommending which of these two mutually exclusive projects Multi-chem should invest in, if any. Your recommendation should be supported by appropriate calculations. Assume Multi-chem has a cost of capital of 12% for domestic projects and 16% for international projects.

Task #2: Tomewin Water Company

Role and Context
You are a newly-hired financial analyst with Tomewin Water Company (TWC), a company operating in most states of Australia, which specialises in bottling purified water sourced from Tweed Valley springs. TWC is considering adding to its product mix a ‘healthy' bottled water geared towards children, aimed at improving both its business focus and the return to shareholders.

Scenario
TWC currently has 30,000,000 ordinary shares outstanding that trade at a price of $41 per share. TWC also has 500,000 bonds outstanding that currently trade at $923.38 each. The company's bonds have 20 year to maturity, a $1,000 par value and a 8% coupon rate that pays interest semi-annually. TWC has no preferred equity outstanding and has an equity beta of 1.30. The risk free rate is 1.5% and the market is expected to return 11.5%. TWC has a tax rate of 30%.

The initial outlay for the new project is expected to be $3,000,000, which will be depreciated over the next 3 years using the straight-line method to a zero salvage value, and sales are expected to be 1,250,000 units per year at a price of $2.15 per unit. Variable costs are estimated to be $0.54 per unit and fixed costs are estimated at $50,000 per year. The above estimations are valid for 3 years of project life after which a terminal value of $500,000 in year 3 is expected to cover all cash flows to be earned in the future. For the purpose of this project, working capital effects are ignored.

TWC's CEO, Dr. Bob Green, has asked the finance department if they consider such project to be an acceptable investment. The CFO, Mrs. Sally Johnson, intends to evaluate the project based on the net present value approach. She agrees with Dr. Green on the major assumptions that will affect these cash flows, but they disagree on the appropriate discount rate. Dr. Green believes that they should use the company's weighted average cost of capital (WACC), however, the CFO disagrees, arguing that the bottled water targeted at children has different risk characteristics from the company's current products. She argues that the company's WACC is inappropriate as a discount rate and they should instead use the ‘pure play' approach and estimate a cost of capital based on companies that sell similar type of products. To do this, Mrs. Johnson obtains some data for several comparable companies as follows:

Task

1. The CEO and CFO have asked you to provide a recommendation on the appropriate discount rate to be used in the appraisal of the new project.
2. Concerned about the forecasting risk of this project, they also ask that you perform a risk evaluation in the form of:
- Sensitivity analysis for sales price, variable costs, fixed costs and unit sales at ±10%, ±20%, and ±30% from the base case, showing on a graph which variables are most sensitive;
- Scenario analysis on the following two scenarios:
a) Worst Case: selling 1,000,000 units at a price of $1.85 and variable cost of $0.63 per unit;
b) Best Case: selling 1,550,000 units at a price of $2.25 and variable costs of $0.49 per unit.
3. Based on the above analysis, provide a recommendation on whether TWC should invest in this project.

Attachment:- Assessment Details.rar