Homework answers / question archive / Case Details Part A: Cost of Capital [30 Marks] You are the CFO of Print & Send Australia – a mature publicly listed Australian firm offering corporate printing and packaging products

Case Details Part A: Cost of Capital [30 Marks] You are the CFO of Print & Send Australia – a mature publicly listed Australian firm offering corporate printing and packaging products

Finance

Share With

---

Case Details

Part A: Cost of Capital [30 Marks]

You are the CFO of Print & Send Australia – a mature publicly listed Australian firm offering corporate printing and packaging products. The business has several divisions based around Adelaide, with their head office located in Port Adelaide.

The last annual report and market data provides the following information regarding the financial structure of the company. The financial structure of Print & Send Australia includes:

• Unsecured notes offering investors a 4% per annum coupon rate, paid semi-annually. The 10,400 outstanding unsecured notes mature in 16 years, exhibit traditional $1,000 face values, and are currently trading for $975 each.
• Debentures maturing in 9 years with $1,000 denominations. Each of the 20,000 outstanding debentures pay bondholders a $82 annual coupon and are trading for $1,115 each.
• Cumulative $5.30 preferred stock trading for $69.70 each, with 50,000 in total outstanding.
• Class A common stock trading for $12.90 each, with 4,500,000 outstanding in total. Print & Send Australia has seen an average growth of 6.5% per annum over the past few years due to securing several high value clients. This growth is expected to continue for the next five years, and is then anticipated to stabilise at a more moderate 3% to 4% thereafter. The

company directors have just paid a dividend of $0.92 per share for the last 12 months.

The Reserve Bank of Australia has indicated inflation rates are expected to remain stable at roughly 2% per annum for the foreseeable future. Print & Send Australia is subject to a 27.5% corporate tax rate.

What is the cost of capital of Print & Send Australia?

Part B: Asset Expansion Project [25 Marks]

You have received a confidential envelope containing a draft competitive bid notification for a contract to supply the Adelaide City Council. The cover memo from Print & Send Australia’s CEO asks you to review the bid before it is submitted.

The bid and its supporting documents have been prepared by Print & Send Australia’s sales staff. It calls for Print & Send Australia to print and deliver 3,600,000 tourism booklets over the next 7 years. The proposed selling price, inclusive of shipping fees, is fixed at $5.50 per booklet. The company will have to supply the following quantities per year:

 

You are not usually involved in sales; however, this bid is unusual in a few ways. First, if accepted by the Adelaide City Council, this project would commit Print & Send Australia to a fixed-price long-term contract. Second, producing the tourism booklets would require an investment of $4,500,000 to purchase machinery and to refurbish one of Print & Send Australia’s buildings/plants at Port Adelaide.

Other details relevant to the appraisal of the project include:

• The negotiated price paid by Adelaide City Council for booklets is fixed for the duration of the contract.
• The plant to be utilised for this project at Port Adelaide was built in 1973 and is now idle, as the company had previously centralised their production areas. The plant is fully depreciated, except for the original purchase cost of the land for $60,000.
• The idle plant is located on valuable shorefront property, which you believe could be sold immediately, or in the near future, for $2.5 million in total (inclusive of the land).
• The new machinery and equipment $1.5 million.
• Refurbishing the plant would cost $3 million.
• The $1.5 million investment in machinery and equipment is depreciable on a straight-line

basis over 7 years. The $3 million cost of refurbishing the Port Adelaide plant is depreciable

on a straight-line basis over 10 years.

• The refurbished plant and new machinery are expected to last for many years if maintained.

However, due to is strong competition in the local market it is unclear whether additional orders could be obtained once the Adelaide City Council contract ends. The machinery is specialised for this project with the council, and hence its resale value at the end of 7 years is estimated to be zero at this stage.

• It is thought working capital would average about 10 percent of sales.
• Cost of goods includes fixed costs of $700,000 per year plus variable costs of $1.80 per

booklet. These costs are expected to increase at the annual inflation rate.

A second envelope has also arrived from the company’s Business Development Manager. It contains the details of a proposed offer from a real estate developer to purchase the Port Adelaide land and plant for $2.1 million in cash – although, you have noticed that the offer was subject to Council approval for development of the land as waterfront restaurants and small businesses.

Should you recommend submitting the bid for this competitive tender to the Print & Send Australia at the proposed price of $5.50 per booklet, or make a counteroffer? Comment on critical issues to be considered, including the offer from the real estate developer. Given the stature of the client for this proposed contract, the annual sales aspect is considered low risk and hence it is believed the discount rate used for evaluation purposes could be 2% lower than the company’s weighted average cost of capital.

Part C: Asset Replacement Project [25 Marks]

Print & Send Australia also has an existing operation producing organic paper stationary for local and national events. To produce these products the company currently uses specialised equipment and letterpress machines that were purchased three years ago. These machines are being depreciated on straight line basis over nine years; have six years of remaining life, and a current collective book value of $230,000. It is estimated these machines could be sold today for $192,000. Replacement machines could be purchased today at a cost of $587,000. The replacement machines have an estimated useful life of six years, and an estimated collective salvage value of $110,000 at the end of their useful life. These machines can be depreciated for tax purposes over a five-year straight-line schedule.

The division manager expects, although with voiced uncertainty, that the replacement machines would permit an output expansion of 60,500 units in the first year, 51,425 units in the second year, 43,711 units in the third year, and 37,154 units each year thereafter – from the current annual average output of 139,500 units. It is also anticipated this additional output can be sold for a current average price of $2.45 per unit. While the division manager has expressed some reservations regarding the possible revenue gained from these new machines, one of the big advantages of this project is greater operating efficiency. Again, without total certainty, the managing director expects to save $1.15 per unit in current dollars off the current operating costs over the longer term, but in the first year the savings would only be $0.75 per unit (while the workers learn to use the machines). The new machines would require inventories to be increased by $40,000, while accounts payable would simultaneously increase by $30,000.

As you are the CFO, you are required to determine whether the company should undertake the proposed replacement project? Comment on critical issues to be considered.

Part D: Discussion of Limitations [20 Marks]

Given the uncertainty expressed towards many of the critical valuation factors, comment on any possible limitations of the cost of capital developed in Part A or the recommendations provided in Part B and Part C – along with any assumptions made. Make sure to comment on how uncertain factors impact your valuations, and techniques used to address these concerns.