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New Project Analysis of the Cost of Capital

Essay by   •  December 9, 2012  •  Case Study  •  2,736 Words (11 Pages)  •  1,434 Views

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Table of Contents

1.0 Executive Summary

2.0 Financial Analysis of Ratios

3.0 Benchmark Comparisons

4.0 Estimates of Capital Structure

5.0 (WACC) Weighted Average Cost of Capital

6.0 Estimation of Cash Flow

7.0 Capital Budgeting and Sensitivity Analysis

8.0 Summary

9.0 Appendix

References

1.0 Executive Summary

From the 2011 Annual Report, Seaboard Corporation, Inc (SEB) it reveals that they specialize in the agriculture and transportation businesses in both domestic and international markets. SEB is mainly involved in the production and processing of pork, grain commodity trading, grain and sugar production, ocean transportation and the generation of power in some markets (http://finance.yahoo.com/q/sec?s=SEB+SEC+Filings).

The following detailed report was prepared to assess the overall financial strength of SEB using key financial ratios. In addition, a capital budgeting analysis of a proposed new 8 year, $ 392 million project took place to determine if the company should implement this new project.

The new project requires an initial investment of $ 320 million for the construction of buildings, the purchasing of equipment including their shipping and installation costs. It also requires funds for the net operating working capital of $ 72 million, which equals the stated project requirement of 12% of the estimated first year revenues.

Furthermore, this report will show that by using cash flow estimations the initial outlay of funds will recoup themselves within 1.29 years for the discounted payback method. It has a net present value (NPV) of almost $804 million. Therefore, to continue to add wealth for the shareholders, the implementation of the project should begin as soon as reasonably possible.

2.0 Financial Analysis of Ratios

In analyzing financial ratios, the process allows us to see the relationship of industry measures of financial performance with other businesses that compete in the same market. The two main competitors used for comparisons are Bunge Limited and Tyson Foods both of which publicly trade in the U.S. stock market.

The first measure of financial performance used are the liquidity ratios, which determine any company's ability to pay off its current debt utilizing its current assets on hand. The two charts listed below for SEB with the inclusion of Bunge and Tyson Foods show the current and quick ratios for the years of 2007-2011 for all three companies.

In reviewing the above charts, it is very clear that SEB has exceptionally elevated liquidity ratios compared to its competitors for all 5 years, which suggests that should a downturn in their core business happen, they will be more able to pay their current debt than their competitors will. Simply put, SEB enjoys an especially liquid financial position.

Another standardized unit of financial measurement is the use of the debt ratio, which measures as a percentage, the amount of capital funded both in the short and long term by outside sources (creditors) for its operations. Furthermore, the debt-to-equity ratio is used to measure as a percentage the amount of financed debt correlated to the amount of equity used in its operations. We can also utilize the times interest ratio (TIE) to further analyze the financial data for SEB to compare with its two main competitors.

Listed below are three charts that represent the debt ratio, debt-to-equity ratio and, the TIE ratio for SEB, Bunge and, Tyson.

It is clear in all three charts that SEB fares better than both Bunge and Tyson. It is especially pleasing to see that SEB enjoys a rather huge safety margin with its TIE ratio and should enjoy lower borrowing rates as a financially stable company.

3. Benchmark Comparisons

In the comparison of overall benchmark profitability analysis for SEB, BG and, TSN we must review the gross profit margin, the basic earning power ratio, the return on assets ratio, the return on equity ratio, and the return on sales ratio.

In reviewing the charts listed below, we see that SEB enjoyed a higher GPM then BG and TSN for the five year period used in this project. For the basic earning power ratio, SEB beat BG and TSN in every year except for 2008 and 2010.

For the return on equity ratio and the return on total assets ratio, SEB beat BG and TSN in three out of the five years which suggests that SEB has been consistently strong in its core business units.

Additional tools that can be used in the analysis of financial stability for a business is to use the inventory turnover ratio, the days sales are outstanding ratio, the fixed asset turnover ratio and the total asset turnover ratio. These are commonly referred to asset management analysis ratios

The below listed charts illustrate these ratios. Of concern with these lies within the days sales are outstanding ratio which SEB is significantly higher than BG and TSN. The other ratios are either relatively flat or of no real concern.

Lastly, we can look at the book value for all three companies which are listed in the below table:

Book Values

SEB 1717.27 1460.02 1246.54 1176.50 1088.36

BG 81.48 83.34 70.8 61.13 65.54

TSN 15.29 13.7 11.57 13.3 13.29

SEB's book value is very strong compared to its two main competitors and shows its financial

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