# Financial Statement Analysis

October 29, 2020
###### Corporate Finance
October 29, 2020

Assessment Instructions

• Complete this individual assignment (parts 1-3) by the due date above.
• Please submit written answers and final numbers through the Turnitin “Written Report” link and submit ONE excel spreadsheet you used in calculating answers through “Excel Submission” link (you can use multiple sheets in your one file). Both of these sections will be marked.

Assessment Description

Answer the questions below with reference to the following sources:

1. Company Perspective – The a2 Milk Company Limited

Source 1: The a2 Milk Company Limited Annual Report 2019

Source 2: The a2 Milk Company Limited (A2M.AX) Yahoo Finance https://au.finance.yahoo.com/quote/A2M.AX/

1. a) Consider the 2019 Annual Report of The a2 Milk Company Limited (A2M). Briefly explain

how the “A2M” governance is organized. Do you notice any strategies in place to align

manager and shareholder interests based on the Annual Report? Provide one brief

example.

1. b) What is the Net Working Capital for “A2M” both in 2018 and 2019. What type of current

asset management strategy is the company pursuing? Explain why and what are the pros

and cons of this strategy.

1. c) You are trying to value “A2M” share today (End of June 2019). Assume the current price of

the share in the stock market is \$17.15 and that you would like to hold the investment for 4

years. Assume that “A2M” will pay its first dividend (\$0.5 AUD) one year from now. The

total dividend will be paid as a lump sum (at once). After this you also estimate that the

dividends will grow respectively at 30%, 25% per year. After that (starting in time 3) you

estimate dividends will grow at a constant rate of 5% forever. Assume that today the

Australian treasury notes is 1.5%, the market risk premium is 10% and the beta of “A2M” is

0.8. Based on this price would you purchase the share? Why or why not? [9 marks]

1. d) What was the market capitalization of “A2M”, on the 1 June 2020, assuming that the total

number of share outstanding is the same as per the end of the 2019FY? (Use the closing

price on that day).

1. e) Consider “A2M” 2019 Annual Report. What type of source (non-current) is the company

primarily using to finance its long-term operations? According to you what is the main

1. f) “A2M” wants to reduce its weighted average cost of capital by replacing some of its equity

with long-term debt. Assume that “A2M” would like to raise \$200 million with a new issuing

of bonds. Assume that the issue will have a coupon rate of 3% with a 5 year maturity.

Assume this are semi-annual coupon bonds and each have a face value of \$1.000 and the

required rates of return for similar bonds in the market is 4%. What would be the issuing

price of these bonds? How many bonds does the company have to sell to achieve its target?

1. Capital Budgeting – The a2 Milk Company Limited (A2M)

All amounts are in \$AUD. The “A2M” board of directors (BoD) is exploring the opportunity tovertically integrate the business by acquiring one of its current suppliers. The BoD hasinstructed, one of the Big 4 Consulting firms to perform a screening process amongst the bestdairy farms in Australia with the goal of selecting potential candidates. The firm is asking\$100,000 dollars as a fixed fee for its consulting services. The report generated by theconsulting firm has identified two different dairy farms that can fit the “A2M” business model.Project A has an initial outlay of dollars \$100 million and Project B has an initial outlay of \$150million. Project A will produce 85,000,000 liters of milk starting at the end of year 1 until the endof year 5 and 50,000,000 liters of milk starting at the end of year 6 until the end of year 10. Itwill also incur working capital expenses at the end of year 6 to 9 of \$5 million (this working capitalwill not be recovered). Project B will produce 100,000,000 liters of milk starting at the end ofyear 1 until the end of year 10. It will also incur working capital expenses at the end of year 1to 3 of \$2 million (this working capital will not be recovered). Assume that the average selling

price (farmgate price) of a liter of milk is \$0.5 over the ten years. The operating costs of both

projects will be 30% of the revenues from year 1-10. Both investments will be depreciated on astraight-line basis over ten years to 0 book value. “A2M” has estimated that the dairy farms canbe sold at the end of year 10 respectively for \$50 million (Project A) and 75 million (ProjectB).The tax rate is 30%. All cash flows are annual and are received at the end of theyear. Theweighted average cost of capital for both projects is 10%.

1. a) Calculate the FCFs to each project
2. b) What is the NPV for each project
3. c) What is the Discounted Payback Period for each project?
4. d) What is the IRR for each project?
5. e) Suppose that the “A2M” management payback rule is 6 years. Based on your analysis in b),
6. c) and e) which project should be chosen? Justify your answer with reference to theory.

What other elements could be taken into consideration when selecting the project?

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