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Background Information and Problem Statement

Essay by   •  October 19, 2011  •  Essay  •  737 Words (3 Pages)  •  4,355 Views

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Background Information and Problem Statement

As a shrimp industry Harris Seafood Inc. is one of the biggest producers of frozen shrimp in the United States. Company has reached approximately $33mln of sales by 1979. Despite the risks of supply and demand of shrimp, company has been very successful in terms of average profitability. Our role as analysts was to decide whether processing plant project is a worthwhile addition to Harris Seafoods.

Analyst assumptions

Our valuation of the firm we start in year 1980. We have chosen 48% marginal tax rate. For the financing of the project we have assumed that it will be entirely covered with excess cash that the company produced. More specifically we have estimated our payables to be 9% of YoY sales. Given the information we have decided to use discounted cash flow analysis as our valuation method. From two inflation choices provided, we picked an inflation of 0% as we strongly believe that using 11% inflation would add an additional uncertainty to our analysis, exposing our project analysis to even larger assumption of costs and revenue. As for our cost of capital we assume the rate of 14.3%. For the depreciation and amortization we have used the numbers given in Exhibit 6, along with pounds of shrimp sold and price per pound.

Calculation of Capex and NWC

As our initial capital expenditure for year 1980 we have put the processing plant initial expenditure of $10,035 followed by Selling, general and administrative costs in years 1981-1986. For the net working capital we have decided on the costs of financing the plant which bring it down to the 9% of YoY sales.

Discount rate and growth rate

To calculate the r we have used the Capital Asset Pricing Model (CAPM) to solve for the cost of equity. We have used then, WACC approach to solve for the discount rate assuming the cost of debt to be at13.5% that was given in the case. For the risk free rate we have picked the rate of 7.10% derived from Exhibit 8 data (February 1980, 6 months US Treasury bills interest rate). For the market risk premium we have taken the average historical return rate for the years 1960-1980 which gives approximately 12.80%. When calculating beta for the shrimp processing plant we looked at the beta of the Harris Seafoods and two publicly traded companies Treasure Isle Inc. and Ocean Foods Inc. and estimated beta at 1.25. Knowing that this beta reflects a company's beta rather than the projects beta we elected not base our decision on capm. After careful consideration we decided that the best way to determine the discount rate was by using the cost of the projects debt. There are three different debt scenarios, the first one being financing through newly issued bonds at 13.5%. The second would be a municipal bond through the city of Brownsville at 9.5% , and the

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