Investment Valuation & Presentation: Philip Morris International

Task

1. Analyse fundamental corporate finance decisions and discuss their applications

2. Apply the investment decision rules of the traditional and discounted cash flow methods in analysing investment decisions and discussing the outputs, while utilising the outputs for investment decisions

3. Be able to compute cost of capital; discuss and critically evaluate working capital policies and apply cash management models in
analysing business working capital policies.

Company: Philip Morris International

Ticker: PM

Philip Morris International (PMI) is one of the world’s leading tobacco companies, employing over 80,000 people worldwide. Including Marlboro, the world’s number one cigarette brand, PMI owns six of the world’s top 15 brands. Currently, the company operates 46 production facilities in more than 30 countries.

The company is very actively pursuing the shift to less harmful products and developing smoke-free products, including the IQOS tobacco heating system. This technology not only greatly reduces the harmful chemicals released (compared to the burning of tobacco) but produces vapour that has also shown to be without negative impact on indoor air quality.

This push towards providing its customers with a safer option is part of a larger move towards replacing cigarettes with a range of alternatives less harmful to consumers. In addition, PMI is becoming increasingly environmentally conscious as the statistics for non-recyclable plastics in the environment do not paint a rosy picture.

The company has decided to evaluate the proposal to acquire Terracycle – a recycler of difficult-to-recycle plastics – with a view to producing its own electronic cigarettes using the recycled plastic from Terracycle. The board believes that this proactive move would enable PMI to benefit from substantial savings in recycling costs in the future, as well as making a positive impact environmentally. With additional investment in recycling facilities, PMI aims to, if all goes to plan, become a potential supplier to its
competitors as well.

This is initially viewed by the board as an opportunity to add additional value by aggressively promoting this practice and create valuable market share in a new area.

Together with the company CFO, the investment team has come up with the most likely scenario of figures and is requesting a recommendation for an appropriate investment method for this project.

1) Incremental sales figures are anticipated to grow by $200m per year as PMI can maintain current prices (absorbing Excise Tax increases) and take market share from its competitors.

2) COGS are also expected to slowly decline, as improvements in the cost of production are realised by incorporating Terracycle into the supply chain.

Learning Outcomes

3) The initial outlay is expected to be $975m, which covers the cost of acquiring the Terracycle facilities and expanding the production capacity.

4) Capital expenditure of $20m a year would be required to continue development and expand the recycling facilities.

5) A $25m injection of working capital would be required at the beginning of the project, which would be recovered in the last year
of the project.

Assume the project is for 5 years only, beginning in 2019, as the continuation of the project is dependent on any new regulations that may be enacted on the production and sales of electronic cigarettes.

Philip Morris International is considering financing the project as all equity and it should be valued as such in the first instance. This is due to the fact that the company has sufficient cash and cash equivalents to cover the cost of the initial investment. (Hint: Assume βeta in the Capital Asset Pricing Model (CAPM) is ‘all equity’ for this valuation.)

The CFO has also asked to value the project using 60% debt finance (for the initial investment amount) to determine the overall impact of the interest tax shield on the project and to take this into consideration when making the final recommendation.

(Hint: Assume the same level of debt is held to the end of the project and do not consider the repayment of the debt principal in the valuation.)

A Weighted Average Cost of Capital (WACC) valuation using the company’s current debt-to-equity ratio should also be made.

(Hint: Use the company’s market value of equity for this calculation. You will also need to calculate a leveraged βeta in the Capital Asset Pricing Model (CAPM) for this valuation.)

You are required to value the project using the following methods and present a proposal to the investment committee with your recommended financing method in order for them to approve it:

1) All equity valuation

2) Adjusted Present Value (APV) valuation

3) Weighted Average Cost of Capital (WACC) valuation

There is no upper limit to the number of slides, as you may also use cover pages, section separators, etc. in the presentation.

However, a minimum of approximately 12 slides would be needed to cover all the listed items.

You do not need to include a voiceover for the presentation, but you should make use of the PPT notes section for additional information (remember, the assignment is expected to total approximately 1,500 words).

1) Full investment analysis and recommendation to management for acceptance of the project using the chosen financing method. It is important to include any non-financial reasons that support the recommendation.

2) The approach should be from inside the company, presenting to the company’s Investment Committee.

3) The format should be based on the presentation outline suggested below:

1) Executive Summary (1 slide)

2) Table of Contents

3) Strategic Rationale – reasons for undertaking the investment

(include non-financial as well as financial reasons)

4) Background – current situation facing the company

5) Project Objectives and Content (this provides additional details over and above the Executive Summary)

6) Project Effects and Benefits

7) Project Financials – your figures for the three investment valuations go here. Show the results of all three valuations, highlighting the recommended method – full calculations should not be shown here but rather in the appendix

8) Project Risks – describe at least three risks of undertaking the project and include mitigations for the risks

9) Alternative Scenarios – what other options were considered? Including ‘do nothing’, three alternatives should be shown, with
reasons why they were not chosen

10) Business Performance* (table showing the last three years of company financial performance – you will need to access the company’s annual reports – with short comments on the performance)

11) Appendix – backup slides showing full valuation calculations

Total Revenue (US$m)

Gross Profit (US$m)

Operating Income (US$m)

Net Income (after tax) (US$m)

Return on Assets (ROA) %

Return on Equity (ROI) %

Current (Working Capital) Ratio

1) Valuation calculations and choice of recommended financing method [40 marks]

2) Preparation of presentation and inclusion of all items [40 marks]

3) Business performance and analysis of performance [20 marks]