business project analysis

business project analysis 150 150 Affordable Capstone Projects Written from Scratch

ASSESSMENT CRITERIA

Numerical tasks:

  • Numerical accuracy;
  • Clear workings;
  • Assumptions explained and justified where appropriate.

 

 

Written tasks:

  • Selection and coverage of appropriate relevant arguments;
  • Use of suitable evidence to support the points you make;
  • Good standard of structure and presentation.

Word guidelines (approximate):

1(c), 1(d)  300 words each

2(c), 3(d)  250 words each

3(e)  150 words

 

 

Case 1

Assume it is now January 2018. Ambrose Leisure (‘Ambrose’) is a company that

operates in the leisure sector and owns properties in a number of attractive locations

in the British Isles. It is keen to expand its operations and is currently considering a

proposal for a new construction project near the city of York, provisionally named

Eagles Country Club and Conference Centre, or ‘Eagles’. Ambrose has already

purchased the land for the site and will be able to obtain the necessary permissions

for the construction. The new site would include a health spa and gym, swimming pool

and sauna as well as 270 bedrooms. The site is large enough to allow for significant

expansion in the future if Eagles is successful. In a new move for the company,

Ambrose is also planning to offer business conference facilities, something not offered

at their current sites. Ambrose plans that Eagles will encourage and attract block

bookings from corporate customers as well as private bookings from individuals and

families. Income from the hiring of the conference rooms and from non-residents using

the restaurant and other facilities are expected to provide £226,000 cash flow

contribution per year, in addition to the income received from residents staying at

Eagles.

The construction of Eagles will take two years to complete and the total construction

cost will be £52 million, of which £20.8 million is payable now and £26 million in one

year’s time, with the remainder of the cost being payable two years from now. Tax

depreciation is allowed on these amounts at a rate of 2% per year on a straight-line

basis. Ambrose’s corporation tax rate is 17% and tax is payable in the same year that

the taxable income arises. At the beginning of 2020 Eagles will open and at that time

an investment of working capital of £1.9 million will be required.

The company will finance the Eagles project in the same proportions of debt and equity

as its existing business. At present it has 480 million ordinary shares and a current

share price of £4.45. Its long term debt finance consists of bonds with a coupon rate

of 6% and a market value of £113 per £100 par value. The par value of the bonds is

£450 million. The bonds will be redeemed at par in January 2038.

Based on its experience, the company has produced the following estimated forecast

of the average number of occupied rooms as a percentage of the total, as follows:

Percentage of

occupied rooms

Probability

65%  0.20

75%  0.30

85%  0.20

The average charge for a room for one night is expected to be £134 and this price will

not change if more than one person occupies the room. On average the rooms will be

occupied by 1.5 people. Each occupant will spend on average £60 on food and drink

and £20 on other items available for purchase in the spa facilities and shop, and the

profit margin on these is expected to be 45%.

Annual staff costs are expected to be £5 million and services and maintenance will be

£2.81 million. Ambrose plans to substantially refurbish and redecorate the

accommodation and facilities every four years to maintain a fresh and luxurious image,

at an anticipated cost of £11.5 million. These costs will be allowable for tax purposes

in the same year they are paid. Ambrose expects that in fifteen years’ time from now

(its usual planning horizon), Eagles will have an after tax value of £75 million, excluding

working capital.

All of the values, revenues and costs are expressed in real terms and general inflation

in the UK is expected to be 2.5% per year. The expected annual return on the

FTSE100 index is 9% and the risk free annual interest rate is 2%. The standard

deviation of the company’s returns is 49%, that of the market returns is 31%, and the

correlation of the company’s returns with those of the market is 0.80.

Required

(a) Using suitable calculations, evaluate the net present value of the proposed Eagles

project. You should clearly state any assumptions that you need to make.

(22 marks)

(b) Identify the minimum average rate of room occupation for the project to be viable,

and briefly comment on your result.  (5 marks)

(c) Assess reasons why the project’s true value to Ambrose may differ significantly

from the results of the analysis in part (a), (apart from any mistakes made in your

workings).  (9 marks)

(d) Identify and discuss suitable ways in which the risks of the hotel project might be

incorporated into the evaluation. (9 marks)

 

 

 

 

 

 

Case 2

Natron plc is a mature company with stable cash flows. Its current credit rating is A.

Its finance director is currently assessing the company’s long-term financing structure

and considering whether a change to a different capital structure would be beneficial.

Although the interest on debt has tax advantages, increasing debt in the capital

structure creates additional financial risks which will be reflected in the rate of interest

at which the company can borrow. He estimates that Natron’s cost of long-term debt

finance will reflect its interest cover ratio (earnings before interest and tax, divided by

interest payment) and credit rating as follows:

Interest cover ratio

Credit rating  Cost of debt

7.0 or above  AA  6%

3.5 to 6.9  A  7%

1.5 to 3.4  BB  9%

The corporation tax rate is 19% and this can be assumed to remain constant in future.

Natron’s equity beta is 1.32; the risk-free rate of interest is 2.0% and the expected

return on the market portfolio is 9.5%. Natron’s capital structure is currently 40% debt,

60% equity in terms of market value.

Relevant financial data from Natron’s most recent financial statements is as follows:

£ million

Net operating income  75.000

Depreciation  18.000

Interest  13.600

Capital expenditures  21.000

The finance director is considering two possible changes that might be made in the

capital structure:

Proposal 1: Issue additional equity finance and use the proceeds to redeem half of

the existing debt.

Proposal 2: Increase the company’s debt finance to 1.5 times the current amount, by

additional borrowing which will be used to repurchase equity.

Required:

(a) Calculate the company’s current value, interest cover ratio and weighted average

cost of capital.  (6 marks)

(b) Using suitable calculations, assess the effect of each of the two possible proposals

on the company’s value, interest cover ratio and weighted average cost of capital.

State any additional assumptions that you make.  (11 marks)

(c) Assess the limitations of the calculation methods you have used in (a) and (b),

and advise Natron of other factors that should be considered before making a decision

about any capital restructuring.  (8 marks)

 

 

 

 

 

Case 3

Green plc is a large, diversified conglomerate company which is seeking to acquire

other companies. It has recently divested part of its operations for £20 million and has

retained the cash proceeds from this sale while looking for potential acquisitions. The

Business Development division of Green plc has recently identified an engineering

company – Lilith plc – as a possible acquisition target.

Financial information relating to each company is given below:

Green  Lilith

Market price per share  £3.00  £1.47

Number of shares  26 million  10 million

The board of directors of Green plc believe that the assets of Lilith plc have been

poorly managed and this has depressed the company’s share price. They are

optimistic that with more efficient management a much better level of performance can

be achieved. It is estimated that the acquisition will result in increased after-tax cash

flows for the combined firm, compared to those of the two firms prior to the merger,

with a total present value of £25 million. Whether or not the bid is successful, Green

plc plans to maintain its current distribution policy of a 35% dividend payout ratio in the

future, while Lilith’s payout ratio is 15%. Both firms are entirely equity financed.

Lilith’s shareholders have indicated that they will agree to the acquisition for a premium

of £3.3 million. However, Green’s directors have not yet decided on the form their offer

will take and are considering paying for the acquisition by issuing shares.

Required

(a) Assuming Green pays £18 million cash for Lilith, calculate the value to Green’s

shareholders of the acquisition and the total value and price per share of the merged

company.  (4 marks)

(b) Assuming now that Green issues 6 million new shares to Lilith’s shareholders in

exchange for the whole 10 million of Lilith’s shares, calculate the total value and price

per share of the merged company,  (4 marks)

(c) What is the minimum number of shares Green should offer, such that Lilith’s

shareholders should be willing to participate in the merger? (5 marks)

(d) Suggest and discuss reasons why, in practice, Lilith’s shareholders may prefer a

cash acquisition to a share exchange,  (7 marks)

(e) Advise Green on their best approach to paying for the acquisition of Lilith, giving

your reasons.  (5 marks)


 

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