You are employed as a financial analyst at Tyson (Ticker: TSN). Part of your assignments include auditing projects proposed by the Hillshire Farms division. The Sara Lee brand seeks funding for a new manufacturing facility to produce deserts for food services and for retail sales. The food service deserts will be shipped to food service providers of convention centers, banquet halls, etc., and the retail sales deserts will be sold in the frozen foods sections of grocery stores. The products will be manufactured identically, but the margins for each of the products will differ. Your duty is to examine the financial aspects of the deal and make a recommendation based on your findings. The plan for the proposed facility is to operate with a useful life of six years. If the project produces a viable revenue stream the facility will continue to operate for a much longer time period.
The company wants to begin production of the facility in the spring of 2017 with production and revenue generation beginning in the first quarter of 2018. The project has a projected life of six years. (If the project is accepted, it will surely have a longer useful life, but management wants to be conservative in its analysis. In other words, if the project does not pay off by the beginning of the seventh year of operations the company doesn’t want to do it.) FASB rules indicate the project investment should be depreciated using a 15-year useful life with the MACRS depreciation schedule (see Table A-1 https://www.irs.gov/pub/irs-pdf/p946.pdf). The Hillshire Farms division and the Sara Lee brand have spent $85 million in market research, recipe development and supply chain analysis the project over the last three years.
The project requires an increase of $104 million in working capital. An initial investment of $278 million in production facilities is required to undertake the project. When the project is completed in six years, the company can reclaim $100million from the repurposing and reallocation of the facilities. (Note: The reclamation value is below the accounting value of the facility, so no taxes will be assessed on the revenue from the reclamation.)
The forecasts for the project state that the expected wholesale price of the desserts to retail chains is $6.00 with an expected increase of 4 percent per year for the subsequent five years. Sales forecasts suggest that retail chains will purchase 13 million units (For the project, a unit represents one pie, cake, etc.) should be sold in the initial year with increases of 3 percent per year over the life of the project. The projected price for food service providers is $5.25 with an expected increase of 4 percent per year over the life of the project. Sales forecasts for the food service providers is expected to be 17 million units with an expected increase of 5 percent per year for the next five years.
The variable costs charged to the project are expected to be 38 percent of the revenue generated annually for retail products and 43.5 percent of the revenue generated annually for food service products. The fixed costs attributed to the project are $47 million and will increase by 3.1 percent over the life of the project. The working capital requirements of the project are such that the firm will need to increase working capital by 8 percent per year for the project. Due to tax incentives and agreements with Tyson, the project’s revenue is subject to a tax rate of 24 percent. Because of the uncertainty related to the two differing distribution channels, market acceptance of the new products, and the level of competition, additional risk above Tyson’s current cost of capital exists. Mitigating the risk of the project is Tyson’s expertise with taking similar projects to market; management suggests that a risk adjustment in excess of cost of capital of 2.1 percent is necessary.
Your job is to prepare an analysis of the project and prepare a brief report explaining whether Tyson ought to authorize the Hillshire Farms division to undertake the project. You should consider various evaluation techniques such as NPV, IRR, and profitability index for the analysis. Include in your report any assumptions and sources that you use for discussion and data. Stock and financial data for the firm can be found at Yahoo! Finance, data to determine the market risk premium is available in an academic working paper by Fernandez, Ortiz Pizarro and Fernández Acín, treasury rates can be found from the U.S. Treasury, and bond data is available from the Financial Industry Regulatory Authority.
You will need to submit a copy of a memorandum and an excel spreadsheet model detailing your cash flows. The memorandum should be no more than 2 pages single spaced. You may include additional materials in an appendix (referred to in the memorandum) and any appendices will need to be submitted separately from the memorandum. For a good example of how to write a memorandum. Additionally, Microsoft Word has a template that you can use for your memorandum.