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Pick a CFFA0 between $2,000,000 and $3,500,000 annually for a constant growth firm. We will call this firm the subject firm, and we will assume that this firm’s cash flows from assets are growing at a constant rate of 2% annually. Comparable constant growth firms are selling for $50,000,000 with CFFA0 of $2,750,000 and have a constant growth rate in their Cash Flows from Assets of 3%. Furthermore, assume that you have no reliable way to calculate the subject firm’s WACC. Given all of these conditions, you are to provide an estimate of value for the subject firm.

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Deanna Hettinger
Deanna HettingerLv2
28 Sep 2019

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1. A firm's taxable income is $12M; calculate tax expense. (Atax table follows.) (a) $4,100,000 (b) $4,088,250 (c) $5,100,000(d) $5,088,250 Taxable Income Rate Taxable Income Rate $0-$50K 15%>$335K-10M 34% >$50K-$75K 25% >$10M-151/3M 35%>$75K-$100K 34% >151/3M-$18M 38% >$100K-$335K 39% >$18M35%

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1. A creditor is reviewing Hoffman Electronics’ statements ofretained earnings for the last 3 years. The creditor is trying todetermine whether a substantial loan should be given to HoffmanElectronics. Which question will most likely be answered byreviewing the statement of retained earnings?

a. Does Hoffman Electronics make risky investments that impedethe cash flow of the firm?

b. What was the ending permanent account balance for HoffmanElectronics last quarter?

c. What assets owned by Hoffman Electronics are valuable enoughto cover debt repayment?

d. Does Hoffman Electronics have enough earnings to pay bothdividends and debts?

2. True or false. By reviewing a company’s statement of retainedearnings over multiple reporting periods, an investor can evaluatethe company’s future growth potential based on net incomechanges.

3. A creditor would most likely be interested in reviewing afirm’s statement of retained earnings to determine if the firm

a. exhibits liquidity.

b.can repay its debt obligations.

c.makes risky investments.

d.has sufficient receivables.

4. On statement of cash flow, the repayment of loans iscategorized as a cash flow from ____activities.

a. operating

b. financing

5."Fill in the blank" question: select the correct answer.

In a statement of cash flows, cash inflows that result fromproviding goods to customers are included in the section called“cash flows from_______ activities.

a. investing

b. operating

c. sales

d. investing

6. Creditors want to know whether Photon, Inc. uses itsavailable cash to purchase new equipment. Which section of thestatement of cash flows would provide this information?

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b.Cash flows from sales activities

c.Cash flows from financing activities

d.Cash flows from investing activities

7. Creditors are examining the statement of cash flows forPhoton, Inc. Which of the following questions can be answered byreviewing the statement of cash flows?

a. What is the average net income of Photon?

b.What type of assets does Photon possess?

c.Does Photon reset its temporary accounts?

d.Does Photon pay its bills when they are due?

Capital Budgeting Project

Instructions: This project requires you to apply the conceptsand methods learned in the course. This is an individualproject.

Assignment: You are interested in proposing a new venture to themanagement of your company. Pertinent financial information isgiven below.

Balance Sheet Data

Cash

5,000,000

Accounts Payable and Accruals

13,000,000

Accounts Receivable

24,000,000

Notes Payable

43,000,000

Inventories

39,000,000

Long-Term Debt

52,000,000

Preferred Stock

9,000,000

Net Fixed Assets

125,000,000

Common Equity

76,000,000

Total Assets

193,000,000

Total Liabilities &

Owners’ Equity

193,000,000

Last year’s sales were $170,000,000. The company has 61,50030-year bonds outstanding, with 15 years until maturity. The bondscarry a 9 percent semi-annual coupon, and are currently selling for$975.00. You also have 100,000 shares of perpetual preferred stockoutstanding, which pays a dividend of $8.00 per share. The currentmarket price is $97.00. The company has 6.55 million shares ofcommon stock outstanding with a current price of $18.00 per share.The stock exhibits a constant growth rate of 8.2 percent. The lastdividend (D0) was $0.97 per share.

Your firm does not use notes payable for long-termfinancing.

Your firm’s federal + state marginal tax rate is 31%.

The firm has the following investment opportunities currentlyavailable in addition to the venture that you are proposing:

Project

Cost

IRR

A

18,000,000

22%

B

25,000,000

18%

C

17,000,000

14%

D

32,000,000

11%

E

15,000,000

8%

All projects, including Project I, are assumed to be of averagerisk. Your venture would consist of a new product introduction (Youshould label your venture as Project I, for “introduction”). Youestimate that your product will have a six-year life span, and theequipment used to manufacture the project falls into the MACRS5-year class. The resulting MACRS depreciation percentages foryears 1 through 6, respectively, are 20%, 32%, 19%, 12%, 11%, and6%. Your venture would require a capital investment of $18,200,000in equipment, plus $1,100,000 in installation costs. The venturewould also result in an increase in accounts receivable andinventories of $3,000,000. At the end of the six-year life span ofthe venture, you estimate that the equipment could be sold at a$5,100,000 salvage value. Your venture would incur fixed costs of$1,350,000 per year, while the variable costs of the venture wouldequal 28 percent of revenues. You are projecting that revenuesgenerated by the project would equal $8,100,000 in year 1,$15,400,000 in year 2, $16,000,000 in year 3, $16,700,000 in year4, $11,000,000 in year 5, and $7,000,000 in year 6.

The following list of steps provides a structure that you shoulduse in analyzing your new venture. Note: Carry all finalcalculations to two decimal places.

1. Find the costs of the individual capital components (15points):

a. long-term debt

b. preferred stock

c. retained earnings (use DCF approach)

2. Determine the weighted average cost of capital. (5points)

3. Compute the Year 0 investment for Project I. (5 points)

4. Compute the annual operating cash flows for years 1-6 of theproject. (20 points)

5. Compute the non-operating (terminal) cash flow at the end ofyear 6. (10 points)

6. Draw a timeline that summarizes all of the cash flows foryour venture. (5 points)

7. Compute the IRR, payback, and NPV for Project I. (20points)

8. Prepare a report for the firm’s CEO indicating which projectsshould be accepted and why.

9. Conclude the project with your reflections on what you havelearned from this course and how it has affected your view of yourown job and career.

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