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Corporate Valuation

Title: Laurentian Bakery Case Study

 

Format: ① PDF ② Excel

Topic:

 

As a well-known frozen pizza brand in Canada market, Laurentian Bakery has a 21% market share. They have come across an opportunity to expand their operations to the USA by securing a contract with an American retail store. The company will need to expand its existing facilities in order to cater to this additional demand. Vice president Danielle Knowles, an MBA holder, prepared a capital project expenditure plan for evaluating. According to the analysis conducted, the company will not be able to meet the hurdle rate. However, the WACC is estimated to be lower. It is believed that if the project is discounted at the WACC, it produces a positive net present value. Moreover, the existing plant has reached its full capacity, and it requires an expansion to meet future increases in demand. The project overview is as below:

Strategic Plan
  1. 3-year plan of capital requirements
  2. Link capital spending to business strategies & continuous improvement effect
  3. Achieve the company-wide hurdle rates
Operating Plan
  1. Capital allocation
  2. Identify continuous improvement initiatives
  3. Budget for the associated benefits
  4. Develop a training plan 
Winnipeg plant’s 

expansion options

 Adding a total of 5.3 million frozen pizza sales units by 1998
Expansion proposal Require 6 months for completion:

  1. Expand existing Winnipeg’s building by 60%, $1.3m
  2. Add a spiral freezer, $1.6m
  3. Install a new high speed pizza processing line, $1.3m
  4. Acquire extra warehouse space, $0.6m
Benefit of project
  1. Reduce plant-wide unit cost by $0.019 (50% achievable on a conservative estimate. First year is only 70% of that)
  2. Save $138,000 per annum (YoY increase of 4% following inflation)
Environmental 

concern
  1. Design and installation of sanitary drain systems
  2. Provision of water-flow recording meters
  3. Using ammonia for refrigeration plant

 

Read the case study ‘Laurentian Bakeries’ and answer the following questions: 

  1. What are the key items to keep in mind when determining the free cash flows for investment analysis? 

(ii) Calculate the weighted average cost of capital (WACC) for Laurentian Bakeries. How does the capital structure of a firm/project affect the WACC? 

(iii) Produce a projected capital budgeting free cash flow statement for the expansion of the company’s frozen pizza plant in Winnipeg. You can make the following assumptions: the project will have a life of 10 years, the corporate tax rate will stay at 38.5% per annum throughout the life of the project, inflation rate will be 4% per annum and there will be no salvage value at the end of the life of the project. 

Using your free cash flow statement, calculate the NPV, Payback, and IRR of the project. 

(iv) Without making any calculations, identify and discuss the benefits and risks of making the investment (i.e. expansion of the frozen pizza plant). 

(v) As Danielle Knowles, what recommendation would you make concerning the Winnipeg plant expansion, and why? 

Categories: , Product ID: 1058

Description

Following points are considered to structure the essay:

 

Project overview
Key items for determining free cash flows for investment analysis WACC and capital structure
Assumptions
Cashflow scenario 1: 100% sold
Cashflow scenario 2: 75% sold
Cashflow scenario 3: 50% sold
Payback period
NPV, IRR, Payback comparisons
Benefits and risks (SWOT analysis)
Recommendations 

 

Assumptions:

    • We have made three scenarios with the assumption that the unit cost saving will only be achieved by 50%: 100% sold (best scenario) / 75% sold (realistic scenario) / 50% sold (worst case scenario)
      The project will have a life of 10 years
      The corporate tax rate will stay at 38.5% per annum throughout the life of the project 
  • The inflation rate will be averaged out to 4% per annum 
    • The average operating margin is 15% of sales revenues; operating expense plus COGS is 85% 
    • All extra expenditures (building, spiral freezer, processing line, warehouse space, contingency needs, etc) will be 100% depreciated by using the straight-line depreciation method over ten years 
    • There will be no salvage value at the end of the life of the project
      $40,000 spent on securing the US contract and $223,000 fixed administrative costs are treated as sunk costs already 
  • baked in expenses
    The project rollout will realize unit cost save of $0.019/unit. However, we took a conservative view that only 
  • half of the anticipated savings are realizable for all scenarios. Further, 70% of that savings applied only in Year 1.
    Additional savings of $138k will be realized over ten years. This will increase following the inflation rate of 4%/year 
  • over ten years. (inflation is averaged out and applied to all years) 
  • Capital cost allowance is 100% received and is deducted from taxable profits. This follows Exibit6. 
  • Changes in working capital follows inventory + receivable – payable, calculated back based on the % out of total revenues in 1995. 

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