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Project Memo

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Project Memo

  1. 1. GROUP PROJECT Project Analysis of Laurentian Bakeries Inc.
  2. 2. Memorandum To: Danielle Knowles Vice President of Operations From: Yifan Lin Project Analyst Date: November 10th , 2014 Subject: Winnipeg Expansion Project Analysis This memorandum is to explain the current financial situation of Laurentian Bakeries Inc. based on a comprehensive ratio analysis of year 1993, 1994 and 1995. Also, project analysis will be conducted so that NPV, IRR, Payback Period and Discounted Payback Period are calculated using hurdle rate and WACC rate respectively. Current Ratio, Quick Ratio, and Net Working Capital Ratio are calculated in order to analyze company’s solvency. Solvency is a company’s ability to meet short-term obligation. According to the ratio shown in Appendix A, the short-term liquidity of Laurentian Bakeries Inc. has increased from 1993 to 1995. Activity ratios measure a firm's ability to convert different accounts within its balance sheets into cash or sales. Total Assets Turnover, Accounts Receivable Turnover and Inventory Turnover have increased during year 1993 to 1995, resulting from more efficient management of company’s assets. Interest coverage ratio is used to determine how easily a company can pay interest on outstanding debt. The larger the interest coverage ratio, the more easily the company pays interest to the bank. Based on the calculation shown in Appendix A, Laurentian Bakeries Inc.’ s ability to pay interest has dropped largely due to the increased long-term debt. Profitability ratio including Return on Assets, Return on Equity and Profit Margin can assess a business's ability to generate earnings. Profitability ratio has been decreased from 1993 to 1995, which means Laurentian Bakeries Inc.’s ability to make money has decreased.
  3. 3. Project Analysis Laurentian Bakeries Inc. is faced with a project proposal requiring the company to invest $5.2 million for building, equipment and warehouse at first as initial investment. In terms of sales, there is 0.5 chance customer will order full guaranteed amount, 0.5 chance will order only 50% of guaranteed amount. Based on this assumption, thus, the unit amount in 1996-1998 are 9.825, 11.175 and 12.15 (million) as shown in Appendix B, and the revenue in each year are 17.203575 20.15444775 and 22.57027619 million (the price in 1995 is $1.7, the inflation rate is assumed as 3% based on the referred inflation rate from US) The total operating cash flow from 1995-1998 are 0, 1.741746813, 2.109795906 and 2.276112958 (million) as shown in Appendix C OCF row (in million). We assume that this company need 30% of next year’s revenue as its working capital, then changing working capital cash flow (NWC) can be found out in Appendix B Working Capital table which are -0.55125, -0.34125 and 4.2525 million from 1996 to 1998. We also assume that this company’s CCA rate for PPE is 20% which is most common CCA ratio, thus we have got the ending UCC for PPE in 1998 is 2.9952 million; and we assume that the salvage value of PPE decrease 10% from original price each year so the salvage value for PPE in 1998 is 3.64 million; thus, the after tax salvage value for PPE is 0.41912 million (seen Appendix B Residual value (PPE) table & CCA table). Those figures result in the total investment cash flow from 1995-1998 are -5.41, -0.55125, -0.34125 and 4.67162 (million) which are shown in Appendix C Total Investment CF row. So the total net cash flow from 1995-1998 are the sum of operating cash flow and investment cash flow which are -5.41, 1.190496813, 1.768545906 and 6.947732958 million. The risk free rate is 7.66%, and cost of equity is 12.76% (beta is 8%, risk premium is 5%), cost of debt is 9.66%, so the WACC rate is 10.17%. Based on the WACC rate, we have got the following results: NPV is around 2.11 million, IRR is 27% which is bigger than the WACC (10.17% ), Payback period is around 2.35 years and Discounted payback period is 2.55 years. And based on the hurdle which is 18%, and those analysis results are: NPV is around 0.93 million, IRR is 27% which is bigger than the hurdle rate, Payback period is around 2.35 years and Discounted payback period is 2.74 years. Thus, our conclusion is that since the NPVs based on the WACC rate and the hurdle rate are both positive, and the IRR rates under two rate are bigger than both WACC and hurdle rate, this project is acceptable because it can help company to create more value. After implementing this project, the company can get back its investment in 2.35 years based on the WACC rate and in 2.55 years based on the discounted cash flow under the WACC rate. For hurdle rate is 18%, the company can cover its investment in 2.35 years and 2.74 years based on the discounted cash flow.
  4. 4. Recommendations  Based on the previous analysis, our recommendation is to take this project because NPVs based on the WACC rate and the hurdle rate are both positive, and the IRR rates under two rates are bigger than both WACC and hurdle rate, this project is acceptable because it can help company to create more value  Company should consider to utilize leverage such as issuing bonds for tax saving purpose and reducing relieving financing pressure.  Company can utilize purchased equipment after the project for other production purpose for achieving more benefits instead of selling them since the assumed usage life of both equipment, warehouse and building are 10 years, this project just keep 3 years.  Company can look for other potential customers in the market for selling them the left amount of products if our target customer just order 50% of guaranteed amount, and company can gain more revenue based on the diversified strategy.  Company can consider to utilize the recovered initial investment (after Payback period) to repurchase stocks or to claim dividends for increasing shareholder value.  Company can also keep working capital for future production which can help company to create continuous revenue after finishing the project in three years instead of selling all working capital  Since there is a great amount of cash out flow for the project in 1995, the company should prepare more cash as its current assets for supporting this project by issuing bonds or stocks.  Company can also utilize the recovered initial investment to purchase risk free financing assets due to the high risk free rate which is 7.66%.
  5. 5. Appendix A 1993 1994 1995 1993-1995 Average Short-term solvency Current Ratio 2.926829 3.184783 3.4 3.170537292 Quick Ratio 2.170732 2.467391 2.733333 2.457152115 NWC Ratio 0.266442 0.307339 0.349515 0.307765278 Activity Ratio Total Assets Turnover 2.675978 2.8 2.737988827 Receivable Turnover 8.294372 8.353909 8.32414088 Average Collection Period 44.00574 43.69212 43.84892968 Inventory Turnover 4.484375 4.485294 4.484834559 Days in Inventory 81.39373 81.37705 81.3853887 Financial leverage ratios Interest Coverage 15.22222 14.4 9.5 13.04074074 Profitability Ratio Return on Assets 0.065758 0.061091 0.063424364 Return on Equity 0.116976 0.114911 0.115943415 Profit Margin 0.094298 0.085595 0.082759 0.087550619
  6. 6. Appendix B
  7. 7. Appendix C 1995 1996 1997 1998 Price 1.751 1.80353 1.857636 # of Unit (in millions) 9.825 11.175 12.15 Sales (in million $) 17.203575 20.15445 22.57028 Operating Expense (in million) 14.623039 17.13128 19.18473 Gross Margin (15% of Sale, in million) 2.5805363 3.023167 3.385541 Plantwide Cost Savings/Unit 0.0114 0.019 0.019 Plantwide Cost Savings (in million) 0.112005 0.212325 0.23085 Other Savings (in million) 0.138 0.14214 0.146404 CCA (in million) 0.434 0.768 0.593 EBIT (in million) 2.397 2.610 3.170 Tax Expense (35%, in million) 0.8387894 0.913371 1.109428 Net income (in million) 1.558 1.696 2.060 OCF (in million) 1.7417468 2.109796 2.276113 Investment CF NWC -0.21 -0.55125 -0.34125 4.2525 PP&E -5.2 After Tax Salvage 0.41912 Total Investment CF -5.41 -0.55125 -0.34125 4.67162 Total CF -5.41 1.1904968 1.768546 6.947733 Culmulative CF -5.41 -4.219503 -2.45096 4.496776 Dsiounted CF -5.41 1.080623353 1.4571644 5.1961473 Culmulative Discounted CF -5.41 -4.32937665 -2.87221 2.323935

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