CHL Agriculture & Aquaculture Pty Ltd
A wholly owned subsidiary of Cunningham Holdings Ltd
Memo
To: All Executive Staff – Aquaculture Division
From: John Chiu, CFO, CHL Agriculture & Aquaculture
Date: 6 September 2020.
Subject: Assessment 2 – Engine for Cairns Prawn Processing Facility - Purchase
and Replacement Policy
Dear All,
It has been noted for some time that a possible area for expansion for our aquaculture business
could be the development of a concentrated prawn processing facility in North Queensland
that could be used to meet our strategic objective of the expansion of new partnerships and
joint primary production and manufacturing initiatives with local industry competitors and
further exploration of export market potential into Asian markets.
In 2019 CHL Aquaculture was successful in obtaining a grant from the Northern Infrastructure Fund
(NIF) to develop export capability of prawns to China. This grant enables CHL Aquaculture to
proceed with the construction of a prawn processing facility in Cairns, helping both aquaculture
and marine producers to process their product locally and send it to China through Cairns’
International Airport.
This government grant provides an opportunity for CHL Aquaculture to expand its
operations, increase revenue and profitability.
In light of this great win for our business - Mr. Anthony Cicchetti, the manager of our Aquaculture
division, has identified the need for the business to consider its investment requirements for
equipment for the prawn processing facility. In doing this, it is important that we recall that the
Board of our parent company has decided that we should incorporate a ‘sustainability’ objective in
our decision-making. That is, when we make an investment decision, we should choose options
that are environmentally sustainable.
One important part of the new facility will be the use of a hy
id engine to operate much of the
water circulation pump equipment in the prawn processing facility. Being a hy
id engine will allow
us to meet our sustainability objective. However, the Board does not wish to purse that objective at
‘any cost’.
This memorandum contains the following information:
• Background information about CCH Aquaculture operations.
• Information about the alternative hy
id engines.
• Analysis to be performed.
Background information about CCH Aquaculture operations
In Australia prawns are fished (wild caught) as well as commercially farmed. Most farms are located
on flat land adjacent to sea water sources, such as are tidal rivers or creeks. Farms extend from
northern New South Wales to far north Queensland but 95% of production takes place in pond-
ased aquaculture in Queensland. In most cases, prawns are sold from the farm as a cooked
product, so an investment in processing infrastructure is necessary, in addition to production
infrastructure.
Pond-based aquaculture requires the use of containment structures, which may include intake
eservoirs, supply channels for water, production ponds, discharge channels and water
treatment ponds. Usually, aquaculture is undertaken in earthen ponds 1–2 metres (m) in depth
formed by a combination of earthworks. The ponds are typically located next to the estuarine
parts of river systems. Most ponds are about 1ha in size and have a gently sloping bottom to
allow for drain harvesting of the prawns and full draining for a dry-out period between crops.
In 2014 Cunningham Holdings Agriculture diversified into aquaculture by acquiring two prawn
farms on the Cassowary Coast in Far North Queensland at Cowley Beach and Mission Beach.
Our prawn farms are located in
the Cassowary Coast region at
Cowley Beach and Mission Beach
in North Queensland
As prawns require temperatures
above 25oC during the production
season. North Queensland provides
these water temperatures year-
ound, which not only provides for
greater production, but also
increases efficiencies, lowers
energy costs and improves
profitability. These outcomes assist
us in achieving our goals in
sustainability, in both economic and
environmental areas.
1
The prawn farms major income is derived from the cultivation of black tiger prawn (Penaeus
monodon) and banana prawns and the associated processing and packaging of prawns for
domestic market distribution. Since operations commenced in 2014, we have grown our business
from 100 tonne to almost 250 tonne, a substantial growth rate for the competitive market in which
we operate.
Our strategic focus is now on the expansion of new partnerships and joint primary production
and manufacturing initiatives with local industry competitors and further exploration of export
market potential into Asian markets. The 2019 grant will provide an opportunity to from the
Northern Infrastructure Fund (NIF) to develop export capability of prawns to China.
Information about the alternative hy
id engines
As discussed above, with the development of the new prawn processing facility in Cairns, we need
to purchase a hy
id engine to operate the pumps used for water circulation. Preliminary analysis
of suitable and available engines has identified two potential alternatives. We need you to consider
the cost of purchasing one of the following possible alternatives:
Alternative 1 – Purchase a second hand engine and perform an extensive overhaul
and reconditioning of the engine.
Alternative 2 – Purchase a new engine.
The two machines are designed differently but have identical capacity, can perform the same
tasks and have similar environmental impacts. It is expected that after seven years both machines
egin to have excessive non environmentally friendly emissions).
The selected engine (whether new or overhauled) is expected to have a life of approximately 10
years by which time it will need to be replaced. As our business grows and consistent with our
‘sustainability’ objective we may wish to replace this equipment earlier after either five or seven
years. Cu
ently the firm does not have a purchase and replacement policy that can be applied.
The choice of engine is an investment decision like any other, except we also need a policy on
when to replace the engine. So, when we make this decision, we are essentially making a decision
about projects of differing lives – a five-year project, a seven-year project or ten-year project.
The analysis must be conducted on a pre-tax basis (therefore assume that depreciation and taxation
do not need to be included in any calculations).
You should use 11.00% as the required rate of return (discount rate) in your analysis.
2
Details of the two alternatives incorporating assumptions to be used in the analysis are as follows:
Alternative 1 1. Purchase second hand “Electro Spark” hy
id engine and spare parts for
maintenance for $ 178,180. (Payment to be made immediately)
2. Costs associated with overhaul and reconditioning of the second hand
engine (payment to be made immediately):
Overhaul diesel component of motor 45,000
Overhaul electric part of the motor 55,000
Replace internal gaskets, pistons and bearings 25,000
Clean and repaint engine 10,000
Integration of the engine to Cairns facility 20,000
3. Post-overhaul operating costs per annum:
Fuel 360,000
Labour costs to operate and maintain the 95,000
engine
Maintenance costs 120,000
Insurance 50,000
4. Trade-In Value (engine plus spare parts) when replacing the engine:
5 years 80,000
7 years 50,000
10 years 20,000
Alternative 2 1. Purchase the NEW “Electro Spark 2” hy
id engine and spare parts for
maintenance for $ 930, XXXXXXXXXX% of payment for the engine to be made
immediately with balance due in annual increments of $155,000 in years 1,
2 and 3).
2. It will cost $25,000 to have the engine integrated into the Cairns facility
(Payment to be made immediately).
3. Operating costs per annum:
Fuel 305,000
Labour costs to operate and maintain the 95,000
engine
Maintenance costs 85,000
4. Insurance costs will be $70,000 in year 1 but are expected to reduce by
5% each year as the value of the new engine declines.
5. Trade-In Value (engine plus spare parts) when replacing the engine:
5 years 400,000
7 years 290,000
10 years 180,000
3
Analysis to be performed
Unfortunately, I am leaving the country soon on a business trip and do not have the time to develop the
detailed report for the Board. Therefore, I request that you prepare a short business report
(2000 words) and a spreadsheet (use the provided spreadsheet) detailing the following:
1. Identify and discuss with supporting analysis, if the selected engine was not replaced until 10
years, which alternative should be adopted?
2. Identify and discuss with supporting analysis, if there is any quantitative advantage to holding an
engine for a shorter period of time than 10 years before replacing it. (i.e. 5 or 7 years). For the
purpose of this analysis, assume that this will involve the replacement of an equivalent engine at
either five or seven years).
3. Perform a sensitivity