The Primary Objective of this report is to study the feasibility for Fenland Foods Plc to invest in the foreign company Fresh Farm Foods Co.
Organic Food is those which are grown from the natural seeds rather than from the genetically modified seeds. It is grown without insecticide and pesticides. It is considered to be a 100% perfect food which does not hurt human being body system. And similarly, the way it is grown also will not hurt the ecological balance in the atmosphere.
During 1970 when the green revolution began, many of the farmers moved from growing natural food to genetically modified seeds to support the growing population. The profit was the first motive in their minds. However, this didn’t last long.
The new methods that have been adopted (by using insecticide and pesticides) led to multiple issues such as water pollution, air pollution and soil pollution. Moreover, the farmers were forced to buy seeds for each and every cultivation. There is need for high fertilizer and the costs also started to mount up.
Currently, the farmers have understood that the best way is to grow Organic Food with less or no intervention such as insecticides or pesticides. Moreover, the growing income middle class and increasing disposable income added with people awareness has made people to move toward Organic Food.
Thus the Organic Food Industry is growing at a CAGR of 16% and would reach a market size of US$ 263 Billion by 2022.
The Primary Objective of this report is to study the feasibility for Fenland Foods Plc to invest in the foreign company Fresh Farm Foods Co.
The Secondary Objective is that in case the feasibility is positive then how to protect the Fenland Foods Plc foreign exchange investment from potential foreign exchange exposure risk.
PROFIT AND LOSS PROJECTION – FRESH FARM CO LTD – FY 2021 TO FY 2025
For us to proceed further and do the feasibility study, we have to project the financials of Fresh Farm Foods Co for the relevant period. To project the financials, there is need for couple of assumptions based on the current financial trend of the company, market growth and economic growth etc.
The assumptions has been made by the Finance director of Fenland Foods. Based on his input, the below financials has been projected.
Projection for Fresh Farm | ||
Particulars | FY 2021 | Growth Rate |
Sales | € 870,000 | 12% |
Total Variable Cost | € 495,000 | |
Labour Cost | € 198,000 | 8% |
Other Variable Cost | € 297,000 | 5% |
Fixed Cost | € 130,000 | 5% |
Labour Cost there is a possibility to go up by higher % as well | ||
Ireland Tax Rate | 12.5% |
In the first case, we call something as a base case. Base case is the one in the normal scenario. All the above inputs has been considered as it is and the Net profit for the Financial Year 2021 to 2025 has been projected.
I) Fresh Farm – Base Case | |||||
(Amount in Euro) | |||||
Particulars | FY 2021 | FY 2022 | FY 2023 | FY 2024 | FY 2025 |
Sales | 870,000 | 974,400 | 1,091,328 | 1,222,287 | 1,368,962 |
Expenses: | |||||
Variable – Labour Cost | 198,000 | 213,840 | 230,947 | 249,423 | 269,377 |
Variable – Other Cost | 297,000 | 311,850 | 327,443 | 343,815 | 361,005 |
Fixed Cost | 130,000 | 136,500 | 143,325 | 150,491 | 158,016 |
Total Expenses | 625,000 | 662,190 | 701,715 | 743,729 | 788,398 |
Operating Profit | 245,000 | 312,210 | 389,613 | 478,559 | 580,564 |
Ireland Tax | 30,625 | 39,026 | 48,702 | 59,820 | 72,570 |
Profit after Tax | 214,375 | 273,184 | 340,912 | 418,739 | 507,993 |
In the second case, we call something as a adverse case. In this case, the projection has been made considering that the labour cost is likely to grow by 10% & the Net profit for the Financial Year 2021 to 2025 has been projected. All other factors remains the same.
Projection for Fresh Farm | ||
Particulars | FY 2021 | Growth Rate |
Sales | € 870,000 | 12% |
Total Variable Cost | € 495,000 | |
Labour Cost | € 198,000 | 10% |
Other Variable Cost | € 297,000 | 5% |
Fixed Cost | € 130,000 | 5% |
Ireland Tax Rate | 12.5% |
II) Fresh Farm – Adverse Case | |||||
(Amount in Euro) | |||||
Particulars | FY 2021 | FY 2022 | FY 2023 | FY 2024 | FY 2025 |
Sales | 870,000 | 974,400 | 1,091,328 | 1,222,287 | 1,368,962 |
Expenses: | |||||
Variable – Labour Cost | 198,000 | 217,800 | 239,580 | 263,538 | 289,892 |
Variable – Other Cost | 297,000 | 311,850 | 327,443 | 343,815 | 361,005 |
Fixed Cost | 130,000 | 136,500 | 143,325 | 150,491 | 158,016 |
Total Expenses | 625,000 | 666,150 | 710,348 | 757,844 | 808,913 |
Operating Profit | 245,000 | 308,250 | 380,981 | 464,443 | 560,049 |
Ireland Tax | 30,625 | 38,531 | 47,623 | 58,055 | 70,006 |
Profit after Tax | 214,375 | 269,719 | 333,358 | 406,388 | 490,043 |
Now, we have arrived at the Profit after tax for the FY 2021 to 2025 in both Base case and Negative case.
DISCOUNT FACTOR:
To compute the financial feasibility or to perform capital budgeting study, we must have a discounting factor.
Discounting factor is the expected rate of return from the project or it is considered to be the weighted average cost of capital.
Weighted average cost of capital is the weighted cost of funds that are being used to fund the new project or business. Thus it is necessary for us to compute the Fenland Foods Co Ltd weighted average cost of capital since Fenland Foods is looking to acquire Fresh Farm Foods Co.
COMPUTATION OF DISCOUNT FACTOR
Fenland Foods Co Ltd | |
Beta | 1.7 |
Risk Free rate of return | 0.25% |
Market Return | 5.30% |
Corporate Tax Rate | 21% |
Weighted Average Cost of Capital | |
kPREF = | 5% |
KD = | 7% |
kE = | Rf+β(Rm-Rf) |
kE = | =0.25%+(1.7*(5.3%-0.25%)) |
kE = | 8.8% |
Weightage: | |
Equity | 79% |
Debt | 15% |
Preference | 6% |
Weighted Cost of Capital | 8.10% |
Thus from the above computation, we have found that the Weighted average Cost of Capital is 8.1% for the Fenland Foods Plc.
VALUATION METHODOLOGY:
Capital Budgeting and Investment appraisal is the financial planning process which helps the company to determine whether the investment in the new machinery, or new project or new plant is worth investing or not.
Some of the Capital Budgeting methods are
- Present Value
- Net Present Value
- Internal Rate of Return
- Payback Period
- Discounted Payback Period
- Accounting Rate of Return
As a starting point of the capital budgeting, we can find the Present Value of the future cash flows. When it comes to the cash flow, then the Projected Profit for Fresh Farm Food Co has to be adjusted for non cash expenses. It means that the Profit after tax has to be added with depreciation or amortization.
We have considered 10% of the total fixed assets of Fresh Farm Food Co as depreciation (i.e: 85,000 Euro per year).
Thus for the Base Case:
Particulars | FY 2021 | FY 2022 | FY 2023 | FY 2024 | FY 2025 | |
Profit after Tax | 214,375 | 273,184 | 340,912 | 418,739 | 507,993 | |
Depreciaiton | 85,000 | 85,000 | 85,000 | 85,000 | 85,000 | |
Cash Inflow | 299,375 | 358,184 | 425,912 | 503,739 | 592,993 | |
Present Value | 276,943 | 306,517 | 337,165 | 368,895 | 401,718 | 1,691,237 |
Present Value of the future cash flows is 1,691,237 Euros.
Thus for the Negative Case:
Particulars | FY 2021 | FY 2022 | FY 2023 | FY 2024 | FY 2025 | |
Profit after Tax | 214,375 | 269,719 | 333,358 | 406,388 | 490,043 | |
Depreciaiton | 85,000 | 85,000 | 85,000 | 85,000 | 85,000 | |
Cash Inflow | 299,375 | 354,719 | 418,358 | 491,388 | 575,043 | |
Present Value | 276,943 | 303,552 | 331,185 | 359,850 | 389,558 | 1,661,087 |
Present Value of the future cash flows is Euro 1,661,087
To compute the Net Present Value, we need the proposed outflow to purchase the machinery or the plant or the project. To find the Net Present Value, we have considered the Norfolk Foods Plc which is trading at PE of 12 times.
If we extrapolate the same to Fresh Farm,
Then Valuation of the Fresh Farm = No. of Shares * Market Price per share
Market price per share = Earnings per share * PE multiple
FY 2019 | |
No of Shares | 550,000 |
Earnings per share in 2019 | Euro 0.21 |
Price per share | Euro 2.50 |
Valuation of the company | Euro 1,375,800 |
The Fresh Farm Food Co is value at Euro 1,375, 800 based on the Norfolk Foods Plc’s PE multiple of 12 times.
Net Present Value of the Firm in Base Case:
Year | FY 2020 | FY 2021 | FY 2022 | FY 2023 | FY 2024 | FY 2025 |
Cash Flow | (1,375,800) | 299,375 | 358,184 | 425,912 | 503,739 | 592,993 |
Net Present Value | 291,802 |
Net Present Value of the Firm in Negative Case:
Year | FY 2020 | FY 2021 | FY 2022 | FY 2023 | FY 2024 | FY 2025 |
Cash Flow | (1,375,800) | 299,375 | 302,800 | 324,580 | 348,538 | 374,892 |
Net Present Value | (68,068) |
We find that the NPV of the company is Euro 291, 802 in the base case and it is (Euro 68,068) for the negative case.
The Payback Period for the time period in which the company earns back the invested money in the project.
Base Case | ||||||
Year | FY 2020 | FY 2021 | FY 2022 | FY 2023 | FY 2024 | FY 2025 |
Cash Flow | (1,375,800) | 299,375 | 358,184 | 425,912 | 503,739 | 592,993 |
Payback Period | 4 years |
Negative Case | ||||||
Year | FY 2020 | FY 2021 | FY 2022 | FY 2023 | FY 2024 | FY 2025 |
Cash Flow | (1,375,800) | 299,375 | 302,800 | 324,580 | 348,538 | 374,892 |
Payback Period | 5 years |
We find that the Payback Period for the base case is 4 years and the Payback Period for the Negative case is 5 years.
The Discounted Payback Period is the time period in which the company earns back the invested money post considering the impact of time in the future cash flows. That is, the future cash flows are discounted for time period and then the payback is computed.
Base Case:
Year | FY 2020 | FY 2021 | FY 2022 | FY 2023 | FY 2024 | FY 2025 |
Cash Flow | (1,375,800) | 299,375 | 358,184 | 425,912 | 503,739 | 592,993 |
Discounted Cash Flows | (1,375,800) | 276,943 | 306,517 | 337,165 | 368,895 | 401,718 |
Discounted Payback Period | Little more than 4 years |
Negative Case:
Year | FY 2020 | FY 2021 | FY 2022 | FY 2023 | FY 2024 | FY 2025 |
Cash Flows | (1,375,800) | 299,375 | 302,800 | 324,580 | 348,538 | 374,892 |
Discounted Cash Flows | (1,375,800) | 276,943 | 259,122 | 256,948 | 255,239 | 253,967 |
Discounted Payback Period | Little more than 5 years |
The Accounting Rate of Return is the average profit after tax for the years divided by the average assets.
Base Case:
Year | FY 2021 | FY 2022 | FY 2023 | FY 2024 | FY 2025 |
Profit after Tax | 214,375 | 273,184 | 340,912 | 418,739 | 507,993 |
Average Profit | 351,040 | ||||
Average Investment | 1,375,800 | ||||
Accounting Rate of Return | 25.5% |
Negative Case:
Year | FY 2021 | FY 2022 | FY 2023 | FY 2024 | FY 2025 |
Profit after Tax | 214,375 | 217,800 | 239,580 | 263,538 | 289,892 |
Average Profit | 245,037 | ||||
Average Investment | 1,375,800 | ||||
Accounting Rate of Return | 17.8% |
- I) Present Value of the firm based on the Base Case and the Negative Case is found to be Euro 1,691, 237 and Euro 1,302,219
- ii) The Net Present Value of the firm considering the outflow of Euro 1,375,800 is Euro 291, 802 for base case and (Euro 68,068) for negative case.
iii) The Payback Period is found to be 4 years for the base case and 5 years for negative case.
- iv) The Discounted Payback Period is found to be little more then 4 years in the base case and it is found to be little more than 5 years in the negative case.
- v) The Accounting Rate of Return stands at 25.5% for the base case and 17.8% for the negative case.
VIABILITY:
The Present value of the project from the base case is found to be Euro 1,691,237 (£ 1,457,963) and the Present value of the project from the negative case is found to be Euro 1,302,219 (£ 1,122,603).
Thus the price for the Fresh Farm Food Co is fixed in the band of Euro 1,302,219 and Euro 1,691,237.
The company can finance this purchase through multiple ways.
- i) Fenland Foods Plc’s can fund this purchase of Fresh Farm Co Ltd through 100% Equity financing.
- a) For this equity purchase, the company can raise money from the share holder as equity
- b) The company can raise money from the share holders are preference share capital
- c) The Debt Equity ratio of the company stands 18%. This states that the company is in a healthy position. The company can raise loan from the mother country by pledging its assets and can fund this purchase.
- d) The company also issue bonds or debenture are use the money for this purchase.
- ii) Fenland Foods Plc can also issue Eurobonds in Euro-Zone & raise the money in Euro Currency itself. With the raised loan money, the company can fund its purchase of Fresh Farm Co Ltd.
iii) The company can pledge its assets in UK Bank and get the proceeding in Euro from Ireland bank and use this money as an Equity funding.
FOREX IMPACT:
Forex impact is the change in the cash flow in mother country’s currency due to its appreciation or depreciation in the foreign currency.
In the above financing options, the company is likely to face the foreign exchange impact if its funds its purchase through any of the option mention in point (i).
However, if the company uses any of the option (ii) or (iii), the company is totally protected from foreign exchange impact.
Foreign Exchange Exposure can be protected through the following ways.
- i) The company can purchase the forex options to protect the currency’s adverse movement in the foreign exchange
- ii) The company can take a forward contract it is sure as how much is the cash flow and the time frame
iii) The company can also go for a currency swap with some other company.
- iv) There are also methods such as Payments Netting, Leading and lagging etc
From the above analysis, it is evident that the acquisition of Fresh Farm Food Co by Fenland Foods Plc will help the Fenland to expand its presence across the nations. This will help to company to grow inorganically, expand its presence, and increase its turnover, profitability and finally the shareholder wealth.
We recommend that the Fenland Foods Plc can acquire the Fresh Farm Food Co as it is strategically a huge positive for the company. The valuation of Fresh Farm Food Co is Euro 1,691,237 (£ 1,457,963) on the higher side and Euro 1,302,219 (£ 1,122,603) in the lower side. Any purchase between this bands is good for the company.
1) Richard Pike and Bill Neale, 2006, Corporate Finance and Investments – Decision & Strategies
2) The World of Organic Agriculture – Statistics and Emerging Trends 2008
3) James A. Miles and John R. Ezzell, 1990, The Weighted Average Cost of Capital, Perfect Capital Markets, and Project Life: A Clarification, https://doi.org/10.2307/2330405
4) Internalization Theory and Corporate International Finance – Alan M. Rugman – https://doi.org/10.2307/41164920
5) Sustainable Development and Business Models of Entrepreneurs in the Organic Food Industry – Albert Jolink, Eva Niestan -https://doi.org/10.1002/bse.1826