Busi3500 - CARLETON UNIVERSITY Sprott School of Business...

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CARLETON UNIVERSITY Sprott School of Business BUSI 3500 A Applied Corporate Finance Case 2: Laurentian Bakery Submitted to Isaac Otchere October 13, 2011
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TABLE OF CONTENTS PAGE 1.0 EXECUTIVE SUMMARY 3 2.0 CAPITAL ALLOCATION POLICY 3 3.0 COST OF CAPITAL JUSTIFICATION 6 4.0 NET PRESENT VALUE 7 5.0 CONCLUSION 10 9.0 APPENDICES 11 LIST OF APPENDICES Appendix 1 Authorization for Expenditure Form 11 Appendix 2 Capital Expenditure Approval Process 12 Appendix 3 Business Review Criteria 13 Appendix 4 Weighted Average Cost of Capital Calculation 13 Appendix 5 Income Statement 14 Appendix 6 Balance Sheet 15 Appendix 7 Market Interest Rates 15 Appendix 8 Eligible CCA Reduction 16 Appendix 9 Inflation Rate 16 Appendix 10 Net Present Value Calculation 17 1.0 Executive Summary Established in 1984, Laurentian Bakeries Inc is involved in a highly competitive frozen goods market. Its most recent expansion project involves setting up a frozen pizza production plant in Winnipeg. Determining whether the expansion will be
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beneficial and profitable for the organization depends mainly on factors such as Laurentian’s Capital Allocation Policy, its cost of capital as well as the overall net present value of the project. Laurentian Bakeries’ main philosophy revolves around continuous improvement whether it pertains to its employees or any projects it decides to undertake. The Winnipeg project met the criteria for both the strategic and operating plan which is crucial in determining whether the expansion should occur. The Weighted Average Cost of capital was 10.5% which is significantly lower than the Class 2 hurdle rate of 18% that was used for this project, thus undermining the ultimate net present value. The net present value of the 10 year project with an initial expenditure of 5.2 million was approximately-2.9 million. After assessing these main factors, it was determined that the company should not undergo the expansion. 2.0 Capital Allocation Policy Before any project is accepted by Laurentian Bakeries, it must first be approved by the Capital Allocation Policy. Laurentian Bakeries’ upholds a philosophy which states that “continuous improvement is a way of life at Laurentian”. For this exact reason, in the year 1989 a new policy was created to evaluate managers. Instead of being judged by net present values for project evaluation, managers had to prove strong returns on investments in their divisions as well; thus giving them an urge to continuously improve. Before any capital allocation occurs, each operating division has to create both a strategic and operating plan. The strategic plan is meant to identify and quantify any inefficiencies or lost opportunities in the proposed project along with ways to get rid of them. It must also include a three year plan of capital requirements, link the capital spending to business
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strategies and their very important continuous growth efforts, and lastly it must achieve the company wide hurdle rate. The operating plan occurs concurrently with the strategic plan in the first year
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Busi3500 - CARLETON UNIVERSITY Sprott School of Business...

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