FIN1FOF- Fundamentals of Finance

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FIN1FOF- Fundamentals of Finance
INDIVIDUAL ASSIGNMENT
Semester 1 2024

GUIDELINES
• This assignment requires students to prepare a detailed business report based on a case study by applying financial conceptssuch as capitalstructure, capital budgeting, and others in topics 1-7 in the course.
• This is an individual assignment marked out of 100 and contributes 25% of your overall assessment for FIN1FOF.
• Your report must be submitted via “Assignment Dropbox” on the FIN1FOF subject LMS site by 11:59 pm on Sunday 19th May, 2024. Hard copies will not be accepted. Make sure you have successfully attached your submission before submitting and exiting the Dropbox. Make sure you receive an email confirmation of your submission. If you aren’t sure, go back into Dropbox and check that your submission is attached.

Rubric


N
 D - C
 B - A

< 49%
 50 – 69%
 70% <

Conceptual Skills

Work applies principles of finance correctly in interpreting the problem, discussing results, conclusions, and/or recommendations.

• Frequent errors or unacceptable mistakes indicative of a lack of understanding of the core principles of finance.
 • Interprets the problem, Identifies the correct means of solving the problem, and explains the solution to the problem in a manner which demonstrates an understanding of the principles of finance, though affected by some errors and/or incompleteness.
• Interprets the problem correctly.
• Applies appropriate principles of finance to identify the correct means of solving the problem.
• Explains the solution to the problem in a manner which demonstrates a thorough understanding of the principles of finance.

Quantitative Skills

Work demonstrates an aptitude to analysing and solving problems mathematically, with the assistance of financial technology.

• Frequent errors or unacceptable mistakes indicative of a lack of understanding of the quantitative methods and financial technologies required to solve quantitative problems.
 • Sources inputs and calculates a solution to the problem, though subject to some mistaken inputs, calculation and/or misuse of financial technology.
• Identifies, calculates and/or sources the correct inputs required to solve the problem.
• Calculates the solution to the problem without error.
• Demonstrates skills in being able to solve problems with the use of financial technology.

Reflective Skills 

Work demonstrates an ability to critically reflect on financial data, problems, solutions and advice.

• None or insufficient critical reflection of quantitative solutions, alternative interpretations and options for advice.
 • Some limited critical reflection of quantitative solutions, alternative interpretations and options for advice.
• Critically reflects on the strength and weaknesses of alternative conceptual interpretations of the fact-set, the problem and alternative solution methods.
• Critically reflects on quantitative solutions in light of client needs.
• Critically reflects on any advice flowing from the solutions.

Communicative Skills

Writing demonstrates ability to clearly and accurately communicate financial analysis, solution and advice.

• An absence of, or f requent errors in the presentation of, formulas and calculations.

• Interpretations and explanations are either missing, incomplete, or suffer from poor grammar and/or spelling errors.

• Little or no arguments and/or evidence is provided in support of any advice given.

• Some but not all formulas and calculations are correctly presented.

• The interpretation and explanation of findings and methods is not clearly expressed and includes some poor grammar and/or spelling.

• Arguments and evidence in support of any advice provided is provided but not sufficiently convincing.

• Correctly presents formulas and all calculations on which the solution to the problem is based.

• Clearly and accurately interprets findings and explains methods with few or no grammar and/or spelling errors.

• Convincingly presents the arguments and evidence in support of any advice provided.

Scenario

You work as a financial analyst in the Finance division of the Rural Services Ltd an Australian agribusiness company. Rural Services Ltd provides a range of products and services, across rural Australian towns, through a common distribution channel, including beef cattle feedlots, agricultural retail products, agency services, real estate services and financial services.

A deposit of lithium ore has been discovered recently on rural property owned by the company. Lithium is a critical element used in various applications, especially in the production of rechargeable batteries, which are used in a wide range of devices such as electric vehicles, smartphones, laptops, and energy storage systems. Additionally, lithium is also used in other industries, including aerospace, ceramics, glass, and pharmaceuticals.

The company is in the process of deciding whether or not to develop a mine on the property to extract the lithium to supply the rechargeable battery market in light of the increasing demand for rechargeable batteries. Your company’s Chief Financial Officer has asked you to make a recommendation as to whether or not the company should proceed with such a project, notwithstanding the significant diversification such an investment would represent for the company from its core activities.

In order to analyse the financial viability of the project you obtain the 2023 Income Statement and Balance Sheet for Rural Services Ltd. Moreover, in order to analyse the risk and return of this project, which is so different from the current activities of Rural Services Ltd, you also obtain the 2023 Income Statement and Balance Sheet for Core Lithium Ltd, a small lithium miner listed on the ASX. These financial statements are provided on pages 4 and 5. You calculate some financial ratios to compare the financial performance of the two companies, which are presented on page 6. You also collect some interest rate information, which is presented on page 7.

Rural Service Ltd
2023 Financial Accounts
INCOME STATEMENT
                           million
Sales Revenue
                          1,000.0
Cost of Sales
                           800.0)
Gross Profit
                            200.0
Selling, General and Administrative Expenses
                          (100.0)
EBITDA
                            100.0
Depreciation
                            (50.0)
Interest Expense
                              (7.5)
Pre-Tax Profit
                              42.5
Tax
                            (12.8)
Net Profit
                              29.8


BALANCE SHEET
                                                  million
ASSETS
Cash
                                                       10.0
Accounts Receivable
                                                   200.0
Inventory
                                                   150.0
Property Plant and Equipment
                                                   250.0
Total Assets
                                                    610.0


LIABILITIES
Accounts Payable
                                                                     200.0
Bank Loan
                                                                       25.0
Corporate Bonds
                                                                     150.0
Total Liabilities
                                                                         375.0

SHAREHOLDERS' EQUITY
Ordinary Shares
                        400.0
Retained Earnings
                       (165.0)
Total Shareholders' Equity
                         235.0
Total Liabilities and Shareholders' Equity
                         610.0
Notes
1. The interest rate on the bank loan is 6.00% p.a.
2. The corporate bonds have a credit rating of BB and have 5 years to maturity. They make quarterly coupon payments at a coupon rate of 4% p.a.
3. The ordinary shares are shown on the balance sheet at their book value of $1 per share. They have a beta of 0.51. In 2023, they paid a dividend of $0.03 per share. The dividend is expected to grow at 5% p.a. for the next 3 years, after which it will grow at a constant 3% p.a. in perpetuity.
Core Lithium Ltd
2023 Financial Accounts
INCOME STATEMENT
                      million
Sales Revenue
                         50.6
Cost of Sales
                       (15.8)
Gross Profit
                         34.8
Interest Income
                          3.0
Selling, General and Administrative Expenses
                       (21.0)
Other Non-operating Income/(Expense)
                         (1.5)
EBITDA
                         15.4
Depreciation
                         (3.9)
Interest Expense
                         (2.3)
Pre-Tax Profit
                           9.2
Tax
                         (1.6)
Net Profit
                            7.6

BALANCE SHEET
                                                million
ASSETS
Cash
                                                 152.8
Accounts Receivable
                                                     6.7
Inventory
                                                    28.9
Property Plant and Equipment
                                                  241.2
Other Assets
                                                    73.6
Total Assets
                                                    503.1

LIABILITIES
Accounts Payable
                                                                      31.0
Bank Loan
                                                                      83.6
Other Liabilities
                                                                      33.6
Total Liabilities
                                                                        148.2

SHAREHOLDERS' EQUITY
Ordinary Shares
                       370.9
Retained Earnings
                        (16.0)
Total Shareholders' Equity
                        354.9
Total Liabilities and Shareholders' Equity
                     503.1 6

Financial Analysis of Rural Services Ltd and Core Lithium Ltd

2023

FINANCIAL ANALYSIS
Rural
Services
Ltd
Core
Lithium
Ltd
Sales Revenue/Average PPE Margin
 164%
 31%
Cost of Sales/Revenue Ratio
 80%
 31%
Gross Margin
 20%
 69%
Tax Rate
 30%
 17%

Net Margin


3%
 15%

Net Working Capital/Sales Revenue Ratio


15%
 9%

Net Profit/Equity Return


13%
 2%

Debt/Equity Ratio


74%
 24%
Credit Rating
 BB
 BB
Beta
 0.51
 2.317
Interest Rates
Based on the current yields at which the 5-year and 10-year Government bonds are trading you assume that the 5-year risk-free rate is 3.974% and the 10-year risk-free rate is 4.315%.
The current corporate credit spreads are as presented in the table below.


Rating
Aaa/AAA 
Aa2/AA
A2/A
Baa2/BBB 
Ba2/BB
B2/B
Caa2/CCC
 Ca/CC
Maturity







1 8 28
 52
 80
 201
 319
 852
 1,207
2 22 33 59 87 201 319 852 1,207

3

35 39 65 93 201 319 852 1,207
4 48 44 71 100 201 319 852 1,207
5 45 46 76 108 201 319 852 1,207
6 42 48 82 117 201 319 852 1,207
7 49 53 88 123 201 319 852 1,207
8 57 57 94 129 201 319 852 1,207
9 65 62 100 135 201 319
852
1,207
10 63 63 99 135 201 319 852
 1,207
11 61 63 99 136 201 319 852 1,207
12 60 64 99 136 201 319 852 1,207
13 58 64 98 136 201 319 852 1,207
14 57 65 98 136 201 319 852 1,207
15 55 65 97 137 201 319 852 1,207
16 53 66 97 137 201 319 852 1,207
17 52 66 96 137 201 319 852 1,207
18 50 67 96 138 201 319 852 1,207
19 49 67 95 138 201 319 852 1,207
20 47 68 95 138 201 319 852 1,207
21 45 68 94 139 201 319 852 1,207
22 44 69 94 139 201 319 852 1,207
23 42 69 93 139 201 319 852 1,207
24 40 69 93 139 201 319 852 1,207
25 39 70 92 140 201 319 852 1,207
26 37 70 92 140 201 319 852 1,207
27 36 71 91 140 201 319 852 1,207
28 34 71 91 141 201 319 852 1,207
29 32 72 90 141 201 319 852 1,207
30 31 72 90 141 201 319 852 1,207
Average
45
61
89
129
201
319
852
1,207

Project Information

• You estimate the investment required to undertake the project will be equal to 20% of the Property Plant and Equipment (PPE) shown in the Core Lithium Ltd 2023 Balance Sheet (page 5).
• You are also aware that Rural Services Ltd has budgeted to spend $2 million in professional, geotechnical and legal fees appraising the project before making its final decision.
• You estimate that the revenues in the first year of the project will equal the 2023 Revenue/Average PPE margin you have calculated for Core Lithium, shown on page 6, multiplied by the investment Rural Services will need to undertake the project.
• Further you are advised that the size of the resource is estimated to provide a five year life for the project and that revenues will grow by 35% in year 2, 25% in year 3, 15% in year 4 and 5% in its fifth and final year.
• You decide to be guided by the Cost of Sales/Revenue Ratio you have calculated for Core Lithium, as shown on page 6, which you will apply through the entire five year life of the project.
• Depreciation will be calculated using the diminishing value method with the aim of fully depreciating the investment by the end of the life of the project.
• You decide to apply the tax rate you calculated for Rural Services Ltd, shown on page 6.
• During the life of the project, you estimate that the firm will need to provide for an annual increase in net working capital comprising an increase in Receivables and Stock, less an increase in Payables. You have calculated the Net Working Capital/Sales Revenue Ratio of Rural Services Ltd and Core Lithium shown on page 6. You decide to use the 2023 Net Working Capital/Sales Revenue Ratio of Rural Services Ltd to estimate the annual additional amount of Net Working Capital that will be required to service the Incremental Sales Revenue of the project, estimated each year.
• You also assume that in the year after the final year of the project’s life the firm will recover in full this net increase in working capital.
• In the year after the five year life of the project, you are advised that the company would need to spend $3 million in cleaning up the site and replanting.
• Your research also shows that the equity risk premium on the ASX is between 4 – 6%, so you decide to apply a 5% equity risk premium in your estimation of CAPM.
Tasks
You are required to complete the following tasks.
• Show the formula and complete calculations for each answer you calculate.
• Define all variables of each formula used and show any calculations required to adjust them for use in applying the formula to solving each problem.
• Format your answers as defined in each task.
• When incorporating an answer to a prior task in a subsequent task, use the value as it has been formatted. For example, if a task required you calculate and format as a percentage to 3 decimal places, the answer should be formatted as 1.234%. If this value is subsequently included in the calculation of the answer to a subsequent task, then the value you must use is 1.234% or 0.01234.
Part 1: Calculate Rural Services Ltd’s Weighted Average Cost of Capital (30 marks)

a) Calculate the before-tax cost of Rural Services Ltd’s bank loans and corporate bonds. Show your answer formatted as a percentage to 3 decimal places. (6 marks)

b) Calculate the cost of Rural Services Ltd’s ordinary shares. Show your answer formatted as a percentage to 3 decimal places. (6 marks)

c) Calculate the estimated market value of Rural Services Ltd’s bank loans and corporate bonds. Show your answer formatted as dollar values. (6 marks)

d) Calculate the estimated market value of Rural Services Ltd’s ordinary shares. Show your answer formatted as dollar values. (8 marks)

e) Calculate Rural Services Ltd’s WACC. Show your answer formatted as a percentage to four decimal places. (4 marks)

Please turn over for Part 2

Part 2: Estimate the project’s incremental free cash flows (30 marks)
a) Prepare the depreciation table for project’s investment in PPE, using the Diminishing Value Method. Show your answer formatted as millions to 2 decimal places. (10 marks)
Year
 1
 2
 3
 4
 5
Opening Book Value




less Depreciation




Closing Book Value




b) Prepare the free cash flow table. Show your answer formatted as millions to 2 decimal places. (20 marks)

PROJECT
 0
 1 2 3 4 5
CASHFLOW STATEMENT
 million
 million
 million
 million
 million
 million
Incremental Sales Revenue





Incremental Cost of Sales





Incremental Earnings Before Tax & Depreciation





Depreciation





Pre-Tax Profit





Tax





Net Profit





add back depreciation





Investment





Change in Net Working Capital





Restoration Costs





Net Incremental Cashflow





Please turn over for Parts 3 and 4

Part 3: Calculate the project’s NPV, IRR and Profitability Index (20 marks)

a) Calculate NPV of the project using the parameters you have estimated above. Show your answer formatted as millions to 2 decimal places. (4 marks)

b) Calculate the IRR of the project using the parameters you have estimated above and the IRR function in Microsoft Excel. Show the parameters and values you incorporated in the IRR function as part of your answer. Show your answer as a percentage to 1 decimal place. (4 marks)

c) Calculate the Profitability Index of the project using the parameters you have estimated above. Show your answer as a percentage showing no decimal places. (4 marks)

d) Should the project be accepted based on the assumptions and parameters you have used above? Explain your answer (8 marks).
Part 4: Review and recalculate the project’s NPV, IRR and Profitability Index (20 marks)

a) Based on the analysis of the financial metrics you calculated on page 5 for Rural Services Ltd. and Core Lithium Ltd. What, if any, concerns might you have with the parameters you have used above to estimate the financial viability of the project? (5 marks)

b) If Rural Services Ltd could only proceed with the project, if it proves to be financially viable AND if it is totally financed by share capital, costed based on the estimated cost of a lithium mining company’s share capital, what would be the discount rate you would apply to evaluating the financial viability of the project? (5 marks)

c) Recalculate the NPV, IRR or Profitability Index of the project using this revised discount rate. Note, you need only recalculate ONE of these measures. (5 marks).

d) Based on this revised project evaluation, if Rural Services Ltd could only proceed with the project, if it proves to be financially viable AND if it is totally financed by share capital costed based on the estimated cost of a lithium mining company’s share capital, would you recommend that the project is financially viable? (5 marks)


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