Harris Seafood Case

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Harris Seafood
Question Number One (1) Value the processing plant proposal. Ignore the Industrial Revenue Bond financing. Assume: Market Risk Premium 8.8%, Riskless Rate 11.41%, and Harris Long Term Debt Rate 13.5%. Our approach to valuing the processing plant can easily be decomposed into three distinct steps first, find the value of the foreseeable free cash flows. Next, calculate the terminal value of the project. Finally, take the present value of those flows. The next few paragraphs walk through each of these steps in order of progression. In the first step we analyze the data and calculate the free cash flow from the inception of the project to the foreseeable future. We opted to use Exhibit 7, which incorporates an 11% inflation rate throughout most of the data. While this may seem like a high inflation level in today’s environment, given the time of the case and the most recent economic data, namely the 18.2% annualized increase in consumer prices reported in Exhibit 8, this seems to be much more reflective of the environment than the alternative that was available to us, Exhibit 6, which assumes a 0% inflation rate. Step One: Determine Free Cash Flow for the Foreseeable Future Free Cash Flow Analysis| 1980| 1981| 1982| 1983| 1984| 1985| 1986| Earnings Before Interest, After Tax| 0 | (189)| 2,152 | 3,702 | 4,233 | 4,829 | 5,493 | + Depreciation| 0 | 833 | 787 | 758 | 746 | 748 | 764 | - Change in Net Working Cap| (2,935)| (2,803)| (5,712)| (3,627)| (1,935)| (2,197)| (2,474)| -Capital Expenditures| (7,000)| (777)| (862)| (957)| (1,063)| (1,179)| (1,309)| +Income Tax Credit| 0 | 650 | 0 | 0 | 0 | 0 | 0 |

-Change in Other LT Assets | (100)| (335)| (621)| (334)| (178)| (203)| (228)| Annual Free Cash Flow | (10,035)| (2,621)| (4,256)| (458)| 1,803 | 1,998 | 2,246 |

In the second step we consider the numerous techniques available for calculating the terminal value of the company and consider their respective pros and cons. Step Two: Calculate the Terminal Value of the Company at the End of the Foreseeable Future Five Terminal Value Estimates|

Valuation Metric| When to use| Pros| Cons| Comments|
Liquidation Value| End of life| Ease of calculation| Understates healthy businesses| Infrequently used; expect to receive less than market value for most assets| Book Value| Only accountants are involved in the transaction| No marginal work necessary| Far too conservative| If you ever want to sell a company using book value, call me first| Warranted Price to Earnings Multiple| Investment is outside of the current scope of the business| Improves discount rate assumption| Difficult to source a comparable company| P/E is after interest, so avoid it unless you just want to estimate equity value; use Enterprise ValueEBIAT| No Growth Perpetuity| Mature business, no longer growing| Risk that the company is so small it cannot perform as well| Most companies grow, hence this understates value| Terminal Value= FCFT+1KW| Perpetual Growth| Early stage| Captures upside of growing market share| g is often overstated; should never be >economic growth rate| Terminal Value= FCFT+1*gKW-g|

Applying the best economic model in a given situation is far more important than understanding how to calculate every model. Examining the business strategy for Harris we determined that there are three potential valuation techniques; liquidation, warranted price to earnings multiple, and the perpetuity value. We summarize our findings in the table below: Valuation Technique| Value |

Liquidation Value| 32,193 |
Warranted Price to Earnings Multiple| 43,385 |
Perpetuity Value| 48,206 |

Given that the liquidation value is much lower than the other two, and would only be used in the case of the project’s failure, we believe an equally weighted average of the two remaining valuation techniques is the...
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