Fenland

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.

INTRODUCTION

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.

OBJECTIVE

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

PRESENT VALUE

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

NET PRESENT VALUE

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.

PAYBACK PERIOD

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.

DISCOUNTED PAYBACK PERIOD

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

 

ACCOUNTING RATE OF RETURN

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%

FINDINGS

  1. 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
  2. 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.

  1. 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.
  2. 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.

FINANCING OPTION

The company can finance this purchase through multiple ways.

  1. i) Fenland Foods Plc’s can fund this purchase of Fresh Farm Co Ltd through 100% Equity financing.
  2. a) For this equity purchase, the company can raise money from the share holder as equity
  3. b) The company can raise money from the share holders are preference share capital
  4. 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.
  5. d) The company also issue bonds or debenture are use the money for this purchase.
  6. 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.

  1. i) The company can purchase the forex options to protect the currency’s adverse movement in the foreign exchange
  2. 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.

  1. iv) There are also methods such as Payments Netting, Leading and lagging etc

CONCLUSION

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.

RECOMMENDATION

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.

REFERENCES

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

 

 

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