FINANCE 251: Financial Management

FINANCE 251: Financial Management

2024 Semester 2 (1245)

Assignment PART 1

Instructions:

This is a Group assignment (Part 1) which also includes an Individual component (Part 2). You must form. your own groups (min 2, max 5 people per group.

There are two outputs for this assignment – Part 1: a written business report (identified in Tasks 1 to

5) and Part 2: a written memorandum.

Part 1 of this assignment is worth a maximum of 100 marks and contributes up to 20% of your overall mark for the course.

A Marking Rubric is attached (on the penultimate page) that identifies the way in which marks will be allocated for Part 1 of the assignment.

Part 1: The word-limit for the group report is 1,000 words, excluding table, diagrams etc. This word limit is a maximum, not a target. The due date for this report is 11.59pm on Sunday 6th  October

2024. You must submit your completed assignment on or before this date.

Late Submissions: Any assignment that is submitted late will be subject to a penalty, equivalent to 10% of the total marks available for the assignment, per day or part thereof. No late assignments  will be accepted after 11.59pm on Thursday 10th  October 2024.

You are required to present some of your answers using excel. Please refer to

https://www.learninghub.ac.nz/maths/excel/getting-started-with-excel/for guidance on using excel.

The final requirement in the assessment is to write a report to the Finance Director of Spark New Zealand Limited. Some marks will be awarded for the format of your answer. Please refer to

https://www.learninghub.ac.nz/report-writing/for guidance on report writing.

Where a question requires calculations, you should clearly show these calculations. In the event of an answer being incorrect partial marks may be awarded where workings are show.

This is an assessment item and no further assistance or information about this assignment will be provided by the FINANCE 251 teaching team.

CASE STUDY:     Spark New Zealand Limited (NZE: SPK)

Spark New Zealand Limited (Spark) is one of the leading telecommunications and digital services  companies in New Zealand. The company's origins trace back to the late 19th century when New Zealand’s telecommunications landscape was managed by the New Zealand Post Office, which handled postal, telegraph, and telephone services.

In the early 1980s, New Zealand, like many other countries, recognized the need to modernize and privatize state-owned enterprises to improve efficiency and service quality. This was part of a broader trend of economic liberalization. In 1987, the New Zealand Post Office was split into three separate state-owned enterprises: New Zealand Post Limited (postal services), PostBank (banking services), and Telecom Corporation of New Zealand Limited (Telecom), which took over the telecommunications operations.

In 1990, the New Zealand government sold Telecom to two U.S.-based companies, Bell Atlantic and Ameritech, for NZD 4.25 billion. This sale marked the beginning of a new era for telecommunications in New Zealand, as Telecom became the dominant player in the market. During the 1990s, Telecom expanded its services and infrastructure. It was the primary provider of both fixed-line telephone services and, eventually, mobile communications in New Zealand. Telecom's monopoly over the telecommunications sector was evident, as it controlled the majority of the country's phone lines and infrastructure, leading to criticism over high prices and lack of competition.

In 2001, the Telecommunications Act was passed, which introduced the role of a

Telecommunications Commissioner and paved the way for greater regulatory oversight. This act led

to the unbundling of the local loop in 2006, allowing other service providers to access Telecom's

copper network and offer their services directly to consumers. The unbundling process was a

significant regulatory intervention that aimed to break Telecom's stranglehold on the market and   encourage competition. The competition led to lower prices, better services, and innovation in the industry, benefiting consumers across New Zealand.

In the face of increasing competition and evolving technology, Telecom New Zealand recognized the need to transform. its business model. The company began shifting its focus from traditional fixed-line telephony to broadband, mobile, and digital services. This strategic pivot culminated in a significant rebranding effort. In 2014, Telecom New Zealand rebranded itself as Spark New Zealand

Limited. The name change was more than just cosmetic; it signified a fundamental shift in the company's identity and direction. The new name, "Spark," was chosen to represent energy, innovation, and the company's commitment to igniting possibilities in the digital age.

The rebranding was accompanied by a renewed focus on customer experience, digital services, and technological innovation. Spark invested heavily in expanding its mobile network, particularly in 4G and later 5G technologies. The company also began offering a range of digital services, including cloud computing, cybersecurity, and digital entertainment, positioning itself as more than just a telecommunications provider.

Despite its successes, Spark has faced its share of challenges. The rapidly changing technological landscape has required the company to constantly adapt and innovate. The emergence of new technologies such as the Internet of Things (IoT), Artificial Intelligence (AI), and cloud computing has presented both opportunities and challenges for Spark. Moreover, competition in the telecommunications and digital services sector remains fierce. Spark has had to navigate competition from other telecommunications providers, as well as from global tech giants offering digital services. This competition has driven Spark to continually innovate and find new ways to differentiate itself in the market.

Spark's commitment to sustainability and corporate social responsibility continues to be a key focus, as it strives to contribute positively to New Zealand’s society and environment. Cybersecurity has also become a critical concern for Spark, as the company handles vast amounts of data and provides essential services to millions of customers. Ensuring the security and privacy of customer data has been a top priority, and Spark has invested significantly in cybersecurity measures to protect its network and customers. Spark is also expanding its digital services portfolio and stepping up investment in data centers, as greater use of artificial intelligence and cloud-based services fans demand, leveraging its expertise in telecommunications to offer integrated solutions that meet the evolving needs of businesses and consumers.

The Data Centre Investment Opportunity

A data centre for a telecom company is a specialized facility designed to house critical computing resources, network infrastructure, and data storage systems essential for managing telecommunications services. These data centres are vital for ensuring the reliability, security, and efficiency of a telecom company's operations, supporting everything from voice and data transmission to cloud services, content delivery, and customer data management.

Data centres are often located in secure, geographically strategic locations to ensure optimal network connectivity and disaster resilience. Redundancy is critical, so telecom companies often operate multiple data centres in different regions to ensure continuous service availability. Data centres require a constant and reliable power supply and are usually connected to multiple electrical grids, again to ensure redundancy.

The heart of a data centre consists of rows upon rows of servers that handle data processing, storage, and management. These servers run various applications, from billing systems and customer databases to real-time communication platforms and cloud services. data centres house vast amounts of data, including customer records, call data, and internet usage logs. Data is often  replicated across multiple locations for redundancy and disaster recovery.

Spark’s new data centres will be interconnected with the company’s vast network of fibre optic cables, microwave links, and satellite systems. They will serve as major network hubs, handling immense volumes of data  traffic across local, regional, and international networks. To ensure uninterrupted service, they will be equipped with multiple redundant network paths. This means  that if one connection fails, data traffic can be rerouted through alternative paths, minimizing the risk of downtime.

Given the large amount of power consumed by data centres, telecom companies, including Spark, are increasingly focused on improving energy efficiency. This includes using energy-efficient servers, optimizing cooling systems, and deploying renewable energy sources, such as solar panels or wind turbines, to power the facility. Some telecom companies are investing in green data centers designed with sustainability in mind. These facilities minimize their carbon footprint through energy- efficient designs, advanced cooling techniques like liquid cooling, and the use of environmentally friendly materials.

Many telecom companies offer data center services to enterprise customers, including web hosting, cloud computing, and managed IT services. These services are supported by the same robust infrastructure used for the company’s internal operations. Telecom data centres often serve as distribution points for content delivery networks (CDNs), enabling faster delivery of media content like videos, music, and games to end-users. This is crucial for supporting services like video streaming, online gaming, and other high-bandwidth applications.

Your Role

After your study at the University of Auckland you have been employed by Spark as part of its finance team where you will be reporting directly to Stefan Knight. Mr. Knight is the Finance Director at Spark New Zealand Limited. He is a Chartered Accountant, who began his career at Deloitte working across both Audit and Corporate Finance and has a Bachelor of Commerce in Accounting and Finance from the University of Auckland. Mr. Knight reports directly to Jolie Hodson the CEO and Executive Director of Spark.

Your finance team will work closely with the Network and Operations team and you have been liaising with colleagues from this area on the construction of a suite of data centres. Spark will generate revenue from its data centres by offering a broad array of services, from traditional colocation and hosting to advanced cloud, network, security, and managed services. By leveraging their extensive infrastructure, expertise, and market position, Spark believes it can generate significant revenue streams from their data centres while providing essential services to businesses across various industries. The first stage is the construction of a pair of identical “green” data centres in two different parts of the country for redundancy and disaster recovery. It’s your job to determine the financial viability of this investment.

You have gathered the following detail to assist in your analysis:

Financial Information

Tables: Table 1 – Revenue Generation Estimates

The market for colocation and hosting, advanced cloud, network, security, and managed services is growing exponentially but initial estimates from the sales and marketing division suggest that total revenue from the first year of operation will be $200million.

Revenue growth is anticipated to be extremely high (30%) in the second year of operation followed by growth rates of 25%, 20% and 15% in the years following.

Table 2 – Investment cash-flows

The data centres have an estimated life of five years (the assumption is that by the end of this period more advanced AI enhanced processes will be available that will supersede Spark’s data centres) and will be depreciated on a straight-line basis to a zero book-value.

The initial investment in Property Plant and Equipment is expected to be an initial $175,000,000 with a further $40,000,000 CAPEX for upgrades anticipated in Year 3

PPE will be depreciated on a straight-line basis at 20% p.a. with no residual value expected (the year 3 upgrades however will be depreciated in full over the final two years).

It is anticipated that the average balance of accounts receivables will be equivalent to 2½% of annual sales revenue and that the average balance of accounts payable will be equivalent to 1½% of annual  sales revenue.

Variable operating costs are expected to be 75% of revenue in each year.

Fixed operating costs (excluding depreciation) are expected to be $15,000,000 p.a.

Table 3 – Economic and other data

New Zealand company tax rate – 28%

5-year fixed-rate borrowing rate for Spark New Zealand Limited – 9.00% p.a. The risk-free rate is currently 4.5%p.a.

Due to recent market volatility, particularly in the tech-stock sector, the expected market return is currently around 11.5%.

Table 4 – Simplifying Assumptions

Although the construction of new data centres will take some time, the CAPEX cash-flows should be recorded in Year 0 (and Year 3 for the upgrade).

Revenue and expenses during the course of a year should be recorded at the end of that year. For  example revenues and expenses occurring during the first year of operation should be recorded in Year 1.

Tax on profit in any year is payable in full at the end of that year.

Tax rebates can be off-set against other division profits and represent a cash inflow in the same year they occur.

Table 5 - Company Information

Spark New Zealand Limited is listed on the New Zealand Stock Exchange: SPK. S&P Corporation lists it’s 3-year equity beta as 0.65 but you have decided to undertake your own estimate based on five  years of historical data. You expect that because the data centre business is new to Spark the beta   for this project should be about twice the company’s equity beta.

Spark intends to undertake a round of fundraising to finance this project. The fundraising will consist of two parts:

•    Equity: Spark will complete a rights issue of new shares

•    Debt: Spark will borrow the balance of funding required via a five-year fixed-rate loan.

Once both funding rounds have been completed Spark’s Debt to Equity (D/E) ratio is expected to be 150%.

The Finance Director has indicated he usually works with a payback period of 3 years on most new investments.

Tasks:

1.    Determine Spark’s equity beta and its WACC that is applicable for use in a financial analysis. (Round your WACC calculation upwards to the nearest half percent).  (10 marks)

2.    Prepare an excel table showing the investment opportunity’s cash flows over the five years. (display whole dollar amounts only).  (15 marks)

3.    Calculate the approximate Payback Period, the NPV and the IRR of the investment project.    (10 marks)

4.    You are unsure of the reliability of some of your estimates and want to know how sensitive the project is to volatility in a number of areas. Select three variables that you consider will have the most significant impact on Spark’s investment decision. Use your spreadsheet to conduct a sensitivity analysis on the project by separately changing each of these variables.  (15 marks)

5.    Write a report to Stefan Knight the Finance Director at Spark New Zealand Limited, summarising your findings. Identify whether or not the investment opportunity is financially viable. Make sure to comment on the impact of your sensitivity analysis.

Recommend whether it should or should not proceed and justify your recommendation.   (40 marks)