Need to write a 2000 word business report and excel calculation data report for a corporate finance unit
CHL Agriculture & Aquaculture Pty Ltd A wholly owned subsidiary of Cunningham Holdings Ltd Memo To: All Executive Staff – Aquaculture Division From: John Chiu, CFO, CHL Agriculture & Aquaculture Date: 6 September 2020. Subject: Assessment 2 – Engine for Cairns Prawn Processing Facility - Purchase and Replacement Policy Dear All, It has been noted for some time that a possible area for expansion for our aquaculture business could be the development of a concentrated prawn processing facility in North Queensland that could be used to meet our strategic objective of the expansion of new partnerships and joint primary production and manufacturing initiatives with local industry competitors and further exploration of export market potential into Asian markets. In 2019 CHL Aquaculture was successful in obtaining a grant from the Northern Infrastructure Fund (NIF) to develop export capability of prawns to China. This grant enables CHL Aquaculture to proceed with the construction of a prawn processing facility in Cairns, helping both aquaculture and marine producers to process their product locally and send it to China through Cairns’ International Airport. This government grant provides an opportunity for CHL Aquaculture to expand its operations, increase revenue and profitability. In light of this great win for our business - Mr. Anthony Cicchetti, the manager of our Aquaculture division, has identified the need for the business to consider its investment requirements for equipment for the prawn processing facility. In doing this, it is important that we recall that the Board of our parent company has decided that we should incorporate a ‘sustainability’ objective in our decision-making. That is, when we make an investment decision, we should choose options that are environmentally sustainable. One important part of the new facility will be the use of a hybrid engine to operate much of the water circulation pump equipment in the prawn processing facility. Being a hybrid engine will allow us to meet our sustainability objective. However, the Board does not wish to purse that objective at ‘any cost’. This memorandum contains the following information: • Background information about CCH Aquaculture operations. • Information about the alternative hybrid engines. • Analysis to be performed. Background information about CCH Aquaculture operations In Australia prawns are fished (wild caught) as well as commercially farmed. Most farms are located on flat land adjacent to sea water sources, such as are tidal rivers or creeks. Farms extend from northern New South Wales to far north Queensland but 95% of production takes place in pond- based aquaculture in Queensland. In most cases, prawns are sold from the farm as a cooked product, so an investment in processing infrastructure is necessary, in addition to production infrastructure. Pond-based aquaculture requires the use of containment structures, which may include intake reservoirs, supply channels for water, production ponds, discharge channels and water treatment ponds. Usually, aquaculture is undertaken in earthen ponds 1–2 metres (m) in depth formed by a combination of earthworks. The ponds are typically located next to the estuarine parts of river systems. Most ponds are about 1ha in size and have a gently sloping bottom to allow for drain harvesting of the prawns and full draining for a dry-out period between crops. In 2014 Cunningham Holdings Agriculture diversified into aquaculture by acquiring two prawn farms on the Cassowary Coast in Far North Queensland at Cowley Beach and Mission Beach. Our prawn farms are located in the Cassowary Coast region at Cowley Beach and Mission Beach in North Queensland As prawns require temperatures above 25oC during the production season. North Queensland provides these water temperatures year- round, which not only provides for greater production, but also increases efficiencies, lowers energy costs and improves profitability. These outcomes assist us in achieving our goals in sustainability, in both economic and environmental areas. 1 The prawn farms major income is derived from the cultivation of black tiger prawn (Penaeus monodon) and banana prawns and the associated processing and packaging of prawns for domestic market distribution. Since operations commenced in 2014, we have grown our business from 100 tonne to almost 250 tonne, a substantial growth rate for the competitive market in which we operate. Our strategic focus is now on the expansion of new partnerships and joint primary production and manufacturing initiatives with local industry competitors and further exploration of export market potential into Asian markets. The 2019 grant will provide an opportunity to from the Northern Infrastructure Fund (NIF) to develop export capability of prawns to China. Information about the alternative hybrid engines As discussed above, with the development of the new prawn processing facility in Cairns, we need to purchase a hybrid engine to operate the pumps used for water circulation. Preliminary analysis of suitable and available engines has identified two potential alternatives. We need you to consider the cost of purchasing one of the following possible alternatives: Alternative 1 – Purchase a second hand engine and perform an extensive overhaul and reconditioning of the engine. Alternative 2 – Purchase a new engine. The two machines are designed differently but have identical capacity, can perform the same tasks and have similar environmental impacts. It is expected that after seven years both machines begin to have excessive non environmentally friendly emissions). The selected engine (whether new or overhauled) is expected to have a life of approximately 10 years by which time it will need to be replaced. As our business grows and consistent with our ‘sustainability’ objective we may wish to replace this equipment earlier after either five or seven years. Currently the firm does not have a purchase and replacement policy that can be applied. The choice of engine is an investment decision like any other, except we also need a policy on when to replace the engine. So, when we make this decision, we are essentially making a decision about projects of differing lives – a five-year project, a seven-year project or ten-year project. The analysis must be conducted on a pre-tax basis (therefore assume that depreciation and taxation do not need to be included in any calculations). You should use 11.00% as the required rate of return (discount rate) in your analysis. 2 Details of the two alternatives incorporating assumptions to be used in the analysis are as follows: Alternative 1 1. Purchase second hand “Electro Spark” hybrid engine and spare parts for maintenance for $ 178,180. (Payment to be made immediately) 2. Costs associated with overhaul and reconditioning of the second hand engine (payment to be made immediately): Overhaul diesel component of motor 45,000 Overhaul electric part of the motor 55,000 Replace internal gaskets, pistons and bearings 25,000 Clean and repaint engine 10,000 Integration of the engine to Cairns facility 20,000 3. Post-overhaul operating costs per annum: Fuel 360,000 Labour costs to operate and maintain the 95,000 engine Maintenance costs 120,000 Insurance 50,000 4. Trade-In Value (engine plus spare parts) when replacing the engine: 5 years 80,000 7 years 50,000 10 years 20,000 Alternative 2 1. Purchase the NEW “Electro Spark 2” hybrid engine and spare parts for maintenance for $ 930,000. (50% of payment for the engine to be made immediately with balance due in annual increments of $155,000 in years 1, 2 and 3). 2. It will cost $25,000 to have the engine integrated into the Cairns facility (Payment to be made immediately). 3. Operating costs per annum: Fuel 305,000 Labour costs to operate and maintain the 95,000 engine Maintenance costs 85,000 4. Insurance costs will be $70,000 in year 1 but are expected to reduce by 5% each year as the value of the new engine declines. 5. Trade-In Value (engine plus spare parts) when replacing the engine: 5 years 400,000 7 years 290,000 10 years 180,000 3 Analysis to be performed Unfortunately, I am leaving the country soon on a business trip and do not have the time to develop the detailed report for the Board. Therefore, I request that you prepare a short business report (2000 words) and a spreadsheet (use the provided spreadsheet) detailing the following: 1. Identify and discuss with supporting analysis, if the selected engine was not replaced until 10 years, which alternative should be adopted? 2. Identify and discuss with supporting analysis, if there is any quantitative advantage to holding an engine for a shorter period of time than 10 years before replacing it. (i.e. 5 or 7 years). For the purpose of this analysis, assume that this will involve the replacement of an equivalent engine at either five or seven years). 3. Perform a sensitivity