ADM 1340 Study Guide - Intangible Asset, Big Rock Brewery, Deferral
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What are the Balance Sheet Ratios (debt-to-asset and debt-to-equity ratios) for the following financial information? (PLEASE SHOW WORK SO I CAN UNDERSTAND HOW THIS WAS DONE. Thank you)
GENERAL ELECTRIC CO (GE) CashFlowFlag BALANCE SHEET | ||
Fiscal year ends in December. USD in millions except per share data. | 2014-12 | 2015-12 |
Assets | ||
Current assets | ||
Cash | ||
Cash and cash equivalents | 90208 | 70483 |
Short-term investments | 47907 | 31973 |
Total cash | 138115 | 102456 |
Receivables | 23237 | 27022 |
Inventories | 17689 | 22515 |
Other current assets | 233911 | 18834 |
Total current assets | 412952 | 170827 |
Non-current assets | ||
Property, plant and equipment | ||
Gross property, plant and equipment | 113321 | 90961 |
Accumulated Depreciation | -46934 | -35927 |
Net property, plant and equipment | 66387 | 54095 |
Equity and other investments | 33822 | 12673 |
Goodwill | 76553 | 65526 |
Intangible assets | 14156 | 16745 |
Deferred income taxes | 2541 | 3105 |
Other long-term assets | 41938 | 169721 |
Total non-current assets | 235397 | 321865 |
Total assets | 648349 | 492692 |
Liabilities and stockholders' equity | ||
Liabilities | ||
Current liabilities | ||
Short-term debt | 79231 | 50810 |
Accounts payable | 16338 | 13680 |
Accrued liabilities | 12537 | 15776 |
Other current liabilities | 54990 | 25764 |
Total current liabilities | 163096 | 106030 |
Non-current liabilities | ||
Long-term debt | 222910 | 147466 |
Deferred taxes liabilities | ||
Pensions and other benefits | 40487 | |
Minority interest | 8674 | 1864 |
Other long-term liabilities | 125510 | 98571 |
Total non-current liabilities | 357094 | 288388 |
Total liabilities | 520190 | 394418 |
Stockholders' equity | ||
Preferred stock | 6 | |
Common stock | 702 | 702 |
Additional paid-in capital | 32889 | 37613 |
Retained earnings | 155333 | 140020 |
Treasury stock | -42593 | -63539 |
Accumulated other comprehensive income | -18172 | -16528 |
Total stockholders' equity | 128159 | 98274 |
Total liabilities and stockholders' equity | 648349 | 492692 |
GENERAL ELECTRIC CO (GE) CashFlowFlag INCOME STATEMENT | ||
Fiscal year ends in December. USD in millions except per share data. | 2014-12 | 2015-12 |
Revenue | 148589 | 117386 |
Cost of revenue | 81311 | 82693 |
Gross profit | 67278 | 34693 |
Operating expenses | ||
Sales, General and administrative | 30572 | 17831 |
Other operating expenses | 9995 | |
Total operating expenses | 40567 | 17831 |
Operating income | 26711 | 16862 |
Interest Expense | 9482 | 3463 |
Other income (expense) | -5213 | |
Income before taxes | 17229 | 8186 |
Provision for income taxes | 1772 | 6486 |
Net income from continuing operations | 15457 | 1700 |
Net income from discontinuing ops | -112 | -7495 |
Other | -112 | -331 |
Net income | 15233 | -6126 |
Preferred dividend | 18 | |
Net income available to common shareholders | 15233 | -6144 |
Earnings per share | ||
Basic | 1.51 | -0.62 |
Diluted | 1.5 | -0.61 |
Weighted average shares outstanding | ||
Basic | 10045 | 9944 |
Diluted | 10123 | 10016 |
EBITDA | 35994 | 16496 |
GENERAL ELECTRIC CO (GE) Statement of CASH FLOW | ||
Fiscal year ends in December. USD in millions except per share data. | 2014-12 | 2015-12 |
Cash Flows From Operating Activities | ||
Net income | 15345 | -6126 |
Depreciation & amortization | 9283 | 4847 |
Deferred income taxes | -1186 | 383 |
(Gain) Loss from discontinued operations | 112 | 7495 |
Accounts receivable | ||
Inventory | -872 | -314 |
Accounts payable | 305 | -541 |
Other working capital | -2428 | -1048 |
Other non-cash items | 7151 | 15195 |
Net cash provided by operating activities | 27710 | 19891 |
Cash Flows From Investing Activities | ||
Investments in property, plant, and equipment | -13727 | -7309 |
Property, plant, and equipment reductions | 6262 | 3020 |
Acquisitions, net | 311 | -9744 |
Sales/Maturities of investments | ||
Other investing activities | 2124 | 73521 |
Net cash used for investing activities | -5030 | 59488 |
Cash Flows From Financing Activities | ||
Debt issued | 37548 | 13951 |
Debt repayment | -47038 | |
Preferred stock issued | ||
Common stock issued | 2842 | |
Dividend paid | -8851 | -9295 |
Other financing activities | -48497 | -33672 |
Net cash provided by (used for) financing activities | -16958 | -76054 |
Effect of exchange rate changes | -3492 | -3464 |
Net change in cash | 2230 | -139 |
Cash at beginning of period | 88787 | 91017 |
Cash at end of period | 91017 | 90878 |
Free Cash Flow | ||
Operating cash flow | 27710 | 19891 |
Capital expenditure | -13727 | -7309 |
Free cash flow | 13983 | 12582 |
Compare Companies --- Netflix (NFLX) vs. GEO Holdings (TOK) Compute financial ratios, time value, variables, and returns using industry standard tools for optimizing financial success. Analyze corporate financial data in evaluating past and future financial performances.
Use formulas to calculate the following financial indicators for each year of data: Three fiscal years for Netflix and GEO Holdings for:
o Price to earnings ratio
o Debt to equity ratio
o Free cash flow
o Earnings per share
o Return on equity
o Net profit margin
V. Performance Over Time
A. Analyze the performance of the Netflix over time. What financial strengths and weaknesses does this company have? Consider addressing the free cash flows and ratios you calculated earlier.
B. Analyze the performance of your GEO Holdings over time. What financial strengths and weaknesses does this company have? Consider addressing the free cash flows and ratios you calculated earlier.
C. Analyze how the data differ between these two companies. Why do you think this is? Consider addressing the free cash flows and ratios you calculated earlier.
VI. Investment
A. Are the companies considered growth or value companies? Why?
B. Which companyâs stock is the better investment?
Netflix Inc. (NMS: NFLX) | |||||
Exchange rate used is that of the Year End reported date | |||||
As Reported Annual Balance Sheet | |||||
Report Date | 12/31/2016 | 12/31/2015 | 12/31/2014 | ||
Currency | USD | USD | USD | ||
Audit Status | Not Qualified | Not Qualified | Not Qualified | ||
Consolidated | Yes | Yes | Yes | ||
Scale | Thousands | Thousands | Thousands | ||
Cash & cash equivalents | 1467576 | 1809330 | 1113608 | ||
Short-term investments | 266206 | 501385 | 494888 | ||
Current content library, net | - | - | 2125702 | ||
Current content assets, net | 3726307 | 2905998 | - | ||
Other current assets | 260202 | 215127 | 206271 | ||
Total current assets | 5720291 | 5431840 | 3940469 | ||
Non-current content library, net | - | - | 2773326 | ||
Non-current content assets, net | 7274501 | 4312817 | - | ||
Information technology assets | 185345 | 194054 | 189274 | ||
Furniture & fixtures | 32185 | 30914 | 25758 | ||
Building | 40681 | 40681 | 40681 | ||
Leasehold improvements | 107945 | 107793 | 57339 | ||
DVD operations equipment | 70152 | 88471 | 89144 | ||
Capital work-in-progress | 108296 | 8845 | 12495 | ||
Property & equipment, gross | 544604 | 470758 | 414691 | ||
Less: accumulated depreciation | 294209 | 297346 | 264816 | ||
Property & equipment, net | 250395 | 173412 | 149875 | ||
Other non-current assets | 341423 | 284802 | 192981 | ||
Total assets | 13586610 | 10202871 | 7056651 | ||
Current content liabilities | 3632711 | 2789023 | 2117241 | ||
Accounts payable | 312842 | 253491 | 201581 | ||
Accrued expenses | 197632 | 140389 | 69746 | ||
Deferred revenue | 443472 | 346721 | 274586 | ||
Total current liabilities | 4586657 | 3529624 | 2663154 | ||
Non-current content liabilities | 2894654 | 2026360 | 1575832 | ||
Long-term debt | 3364311 | 2371362 | 900000 | ||
Other non-current liabilities | 61188 | 52099 | 59957 | ||
Total liabilities | 10906810 | 7979445 | 5198943 | ||
Common stock | 1599762 | 1324809 | 60 | ||
Additional paid-in capital | - | - | 1042810 | ||
Foreign currency | -47966 | -42502 | -4615 | ||
Change in unrealized gains on available for sale securities | -599 | -806 | 169 | ||
Accumulated other comprehensive income (loss) | -48565 | -43308 | -4446 | ||
Retained earnings (accumulated deficit) | 1128603 | 941925 | 819284 | ||
Total stockholders' equity (deficiency) | 2679800 | 2223426 | 1857708 |
Geo Holdings Corp (TOK: 2681) | |||||
Due to changes with International Financial Reporting Standards (IFRS), recent financials statement presentations have been adjusted to meet this standard. Please note the original historical presentations have remained in the original format | |||||
Exchange rate used is that of the Year End reported date | |||||
As Reported Annual Balance Sheet | |||||
Report Date | 03/31/2016 | 03/31/2015 | 03/31/2014 | ||
Currency | JPY | JPY | JPY | ||
Audit Status | Not Qualified | Not Qualified | Not Qualified | ||
Consolidated | Yes | Yes | Yes | ||
Scale | Millions | Millions | Thousands | ||
Cash & deposits | 37683 | 32052 | 19869000 | ||
Trade notes & accounts receivables | 4100 | 4077 | 3992000 | ||
Merchandise | 24894 | 23834 | 23495000 | ||
Deferred tax assets | 2156 | 1806 | 1773000 | ||
Other current assets | 5462 | 7181 | 5942000 | ||
Allowance for doubtful accounts | -281 | -292 | 343000 | ||
Total current assets | 74015 | 68659 | 54729000 | ||
Asset for rent, gross | 100974 | 104514 | 104647000 | ||
Accumulated depreciation - asset for rent | -95154 | -97475 | 96055000 | ||
Asset for rent, net | 5820 | 7038 | 8591000 | ||
Buildings & structures, gross | 40872 | 39984 | 39478000 | ||
Accumulated depreciation - buildings & structures | -27470 | -26362 | 25976000 | ||
Buildings & structures, net | 13402 | 13622 | 13501000 | ||
Land, net | 5844 | 6356 | 6651000 | ||
Leased assets, gross | 2176 | 3519 | 4576000 | ||
Accumulated depreciation - leased assets | -681 | -1764 | 2588000 | ||
Leased assets, net | 1495 | 1754 | 1988000 | ||
Other property, plant & equipment, gross | 24838 | 20562 | 17708000 | ||
Accumulated depreciation - other property, plant & equipment | -18391 | -15292 | 13236000 | ||
Other property, plant & equipment, net | 6447 | 5270 | 4471000 | ||
Total property, plant & equipment | 33010 | 34043 | 35205000 | ||
Total intangible assets | 1865 | 1277 | 2028000 | ||
Investment securities | 926 | 1002 | 1266000 | ||
Long-term loans receivable | 2250 | 6682 | 6628000 | ||
Lease & guarantee deposits | 14905 | 14735 | 15034000 | ||
Deferred tax assets | 3342 | 3774 | 2845000 | ||
Other investments & other assets | 1222 | 1188 | 1760000 | ||
Allowance for doubtful accounts | -1332 | -3751 | 3917000 | ||
Total investments & other assets | 21315 | 23632 | 23617000 | ||
Total non-current assets | 56192 | 58952 | 60851000 | ||
Total assets | 130207 | 127612 | 115581000 | ||
Trade accounts payable | 12631 | 13540 | 13124000 | ||
Current portion of long-term borrowings | 8333 | 7097 | 8754000 | ||
Current portion of bonds | 149 | 149 | 249000 | ||
Income taxes payable | 4815 | 265 | 1170000 | ||
Reserve for bonuses | 1665 | 1420 | 1135000 | ||
Other current liabilities | 10135 | 12595 | 10279000 | ||
Total current liabilities | 37731 | 35068 | 34713000 | ||
Bonds | 105 | 254 | 403000 | ||
Long-term borrowings | 19509 | 21843 | 13910000 | ||
Lease liabilities | 1612 | 1660 | 1590000 | ||
Deferred tax liabilities | 23 | 22 | 26000 | ||
Asset retirement obligations | 4406 | 3994 | 3898000 | ||
Other non-current liabilities | 1857 | 1554 | 1839000 | ||
Total non-current liabilities | 27514 | 29329 | 21668000 | ||
Total liabilities | 65246 | 64398 | 56381000 | ||
Capital stock | 8871 | 8615 | 8603000 | ||
Capital surplus | 3283 | 6090 | 6078000 | ||
Retained earnings | 52542 | 49998 | 44381000 | ||
Treasury shares | - | -1979 | 334000 | ||
Total shareholders' equity | 64697 | 62724 | 58729000 | ||
Valuation difference on available-for-sale securities | 166 | 282 | 297000 | ||
Loss (gain) on deferred hedge | -15 | - | 297000 | ||
Total accumulated other comprehensive income | 150 | 282 | 172000 | ||
Stock acquisition rights | 113 | 206 | 59199000 | ||
Net assets | 64961 | 63214 | 115581000 | ||
Total liabilities & net assets | 130207 | 127612 |
Netflix Inc. (NMS: NFLX) | |||||
Exchange rate used is that of the Year End reported date | |||||
As Reported Annual Income Statement | |||||
Report Date | 12/31/2016 | 12/31/2015 | 12/31/2014 | ||
Currency | USD | USD | USD | ||
Audit Status | Not Qualified | Not Qualified | Not Qualified | ||
Consolidated | Yes | Yes | Yes | ||
Scale | Thousands | Thousands | Thousands | ||
Revenues | 8830669 | 6779511 | 5504656 | ||
Cost of revenues | 6029901 | 4591476 | 3752760 | ||
Marketing expenses | 991078 | 824092 | 607186 | ||
Technology & development expenses | 852098 | 650788 | 472321 | ||
General & administrative expenses | 577799 | 407329 | 269741 | ||
Operating income (loss) | 379793 | 305826 | 402648 | ||
Interest expense | 150114 | 132716 | 50219 | ||
Interest & other income (expense) | 30828 | -31225 | -3060 | ||
Income before income taxes - United States | 188078 | 95644 | 325081 | ||
Income (loss) before income taxes - foreign | 72429 | 46241 | 24288 | ||
Income (loss) before income taxes | 260507 | 141885 | 349369 | ||
Current tax provision (benefit) - federal | 54315 | 52557 | 86623 | ||
Current tax provision (benefit) - state | 5790 | -1576 | 9866 | ||
Current tax provision (benefit) - foreign | 60571 | 26918 | 16144 | ||
Total current tax provision (benefit) | 120676 | 77899 | 112633 | ||
Deferred tax provision (benefit) - federal | -24383 | -37669 | -10994 | ||
Deferred tax provision (benefit) - state | -14080 | -17635 | -17794 | ||
Deferred tax provision (benefit) - foreign | -8384 | -3351 | -1275 | ||
Total deferred tax provision (benefit) | -46847 | -58655 | -30063 | ||
Provision for (benefit from) income taxes | 73829 | 19244 | 82570 | ||
Net income (loss) | 186678 | 122641 | 266799 | ||
Weighted average shares outstanding - basic | 428822 | 425889 | 420546 | ||
Weighted average shares outstanding - diluted | 438652 | 436456 | 431893 | ||
Year end shares outstanding | 430054.212 | 427940.44 | 422910.887 | ||
Net income (loss) per share - basic | 0.44 | 0.29 | 0.634 | ||
Net income (loss) per share - diluted | 0.43 | 0.28 | 0.617 | ||
Number of full time employees | 4500 | 3500 | 2189 | ||
Number of part time & temporary employees | 200 | 400 | 261 | ||
Total number of employees | 4700 | 3700 | 2450 | ||
Number of common stockholders | 290 | 237 | 203 | ||
Foreign currency translation adjustments | -5464 | -37887 | - | ||
Geo Holdings Corp (TOK: 2681) | |||||
Exchange rate used is that of the Year End reported date | |||||
As Reported Annual Income Statement | |||||
Report Date | 03/31/2016 | 03/31/2015 | 03/31/2014 | ||
Currency | JPY | JPY | JPY | ||
Audit Status | Not Qualified | Not Qualified | Not Qualified | ||
Consolidated | Yes | Yes | Yes | ||
Scale | Millions | Millions | Thousands | ||
Total revenue | 267910 | 270308 | 262324000 | ||
Cost of sales | -151798 | -157825 | 152301000 | ||
Gross profit | 116112 | 112483 | 110022000 | ||
Selling, general & administrative expenses | -99559 | -102925 | 100823000 | ||
Operating income | 16552 | 9558 | 9198000 | ||
Interest & dividend income | 49 | 114 | 111000 | ||
Rental income | 1268 | 1167 | 1193000 | ||
Other non-operating income | 1043 | 1062 | 453000 | ||
Total non-operating income | 2361 | 2343 | 1758000 | ||
Interest expense | -230 | -231 | 332000 | ||
Rental expenses | -759 | -609 | 595000 | ||
Transfer to reserve for doubtful account | - | -227 | - | ||
Other non-operating expenses | -100 | -803 | - | ||
Total non-operating expenses | -1089 | -1871 | 684000 | ||
Ordinary income | 17824 | 10030 | 1612000 | ||
Imapirment loss | -1319 | -1543 | 9344000 | ||
Other extraordinary losses | -13 | - | 203000 | ||
Total extraordinary losses | -1333 | -1543 | 203000 | ||
Income before income taxes | 16491 | 8486 | 1218000 | ||
Income taxes - current | -5779 | -2074 | 514000 | ||
Income taxes - deferred | -147 | 925 | 87000 | ||
Total income taxes | -5927 | -1149 | 1821000 | ||
Profit | 10563 | 7337 | 7726000 | ||
Profit attributable to owners of parent | 10563 | 7337 | 4027000 | ||
Average number of shares outstanding - basic | 51.331 | 53.169 | -39000 | ||
Average number of shares outstanding - diluted | 51.623 | 53.29 | 3987000 | ||
Year end shares outstanding | 48.244 | 52.295 | 3738000 | ||
Earnings per share - basic | 205.78 | 137.99 | -70000 | ||
Earnings per share - diluted | 204.62 | 137.68 | 3808000 | ||
Number of full time employees | 3825 | 3579 | 53996.5 | ||
Number of part time employees | 10421 | 10114 | 54066.499 | ||
Number of common stockholders | 57105 | 65030 | 53996.5 | ||
Making Long Term FM Decisions - Integrative Case
Introduction: As a special analytical group set up by ACME Iron by the firmâs Controller, you have been tasked to respond to the following issues raised in a meeting with the CFO.
You must look over several prospective financial strategies to aid in the successful growth of ACME Iron: Capital investment analysis; CAPM â Capital Asset Pricing Model determination for the company; WACC â Weighted Average Cost of Capital computations; EVA â Economic Value Analysis; MVA â Market Value Added; Capital structure of the company; Dividend policy; Stock repurchase and option pricing strategy; Bankruptcy risk analysis; Decision Tree Creation; Real option analysis of projects
The CFO wants to test you out on a simple project in the first task before you get into preparing items for his board presentation in subsequent tasks and projects. He wants to see how well you perform tasks as well as how accurate and thoughtful you are in your work. Details are important to him as well as good organization/presentation and communication.
Financial Statements for use on Tasks
ACME Iron | Balance Sheet | ||
Assets | |||
Current assets: | 2014 | 2015 | change |
Cash | 500,000 | 600,000 | 100,000 |
Investments | 1,000,000 | 1,025,000 | 25,000 |
Inventories | 110,000,000 | 117,000,000 | 7,000,000 |
Accounts receivable | 11,750,000 | 12,500,000 | 750,000 |
Pre-paid expenses | 2,500,000 | 2,600,000 | 100,000 |
Other | 0 | 0 | - |
Total current assets | 125,750,000 | 133,725,000 | 7,975,000 |
Fixed assets: | 2014 | 2015 | change |
Property and equipment | 165,000,000 | 175,000,000 | 10,000,000 |
Leasehold improvements | 0 | 0 | - |
Equity and other investments | 55,000,000 | 65,000,000 | 10,000,000 |
Less accumulated depreciation | 15,000,000 | 15,500,000 | 500,000 |
Total fixed assets | 235,000,000 | 255,500,000 | 20,500,000 |
Other assets: | 2014 | 2015 | change |
Goodwill | 75,000,000 | 70,000,000 | (5,000,000) |
Total other assets | 75,000,000 | 70,000,000 | (5,000,000) |
Total assets | 435,750,000 | 459,225,000 | 23,475,000 |
Liabilities and owner's equity | |||
Current liabilities: | 2014 | 2015 | change |
Accounts payable | 40,500,000 | 42,400,000 | 1,900,000 |
Accrued wages | 85,000,000 | 90,500,000 | 5,500,000 |
Accrued compensation | 10,000,000 | 10,855,000 | 855,000 |
Income taxes payable | 4,024,000 | 4,697,000 | 673,000 |
current portion of LT debt | 5,500,000 | 10,350,000 | 4,850,000 |
Other | 0 | 0 | - |
Total current liabilities | 145,024,000 | 158,802,000 | 13,778,000 |
Long-term liabilities: | 2014 | 2015 | change |
Long term debt | 125,000,000 | 130,000,000 | 5,000,000 |
Total long-term liabilities | 125,000,000 | 130,000,000 | 5,000,000 |
Owner's equity: | 2014 | 2015 | change |
Common stock | 122,000,000 | 122,000,000 | - |
Preferred stock | 16,725,000 | 16,725,000 | - |
Accumulated retained earnings | 27,001,000 | 31,698,000 | 4,697,000 |
Total owner's equity | 165,726,000 | 170,423,000 | 4,697,000 |
Total liabilities and owner's equity | 435,750,000 | 459,225,000 | 23,475,000 |
Income Statement
ACME Iron
December 2015
Financial Statements in '000s of U.S. Dollars
REVENUE | ||
Gross Sales | 250,000 | |
Less: Sales Returns & Allowances | 2,500 | |
Net Sales | 247,500 | |
COST OF GOODS SOLD | ||
Beginning Inventory | 7,500 | |
Add: Purchases | 4,500 | |
Freight-in | 0 | |
Direct Labor | 75,000 | |
Indirect Expenses | 15,000 | |
Inventory Available | 102,000 | |
Less: Ending Inventory | ||
Cost of Goods Sold | 102,000 | |
Gross Profit (Loss) | 145,500 | |
EXPENSES | ||
Advertising | 7,500 | |
Amortization | 0 | |
Bad Debts | 5,000 | |
Depreciation | 500 | |
Dues and Subscriptions | 0 | |
Employee Benefit Programs | 18,750 | |
Insurance | 2,500 | |
Interest | 10,350 | |
Legal & Professional Fees | 100 | |
Licenses & Fees | 0 | |
Miscellaneous | 10 | |
Office Expenses | 100 | |
Payroll Taxes | 5,625 | |
Postage | 3 | |
Rent | 0 | |
Repairs & Maintenance | 5,000 | |
Supplies | 2,000 | |
Telephone | 120 | |
Travel | 1,750 | |
Utilities | 50,000 | |
Vehicle Expenses | 450 | |
Wages | 25,000 | |
Total Expenses | 134,758 | |
Net Operating Income | 10,742 | |
OTHER INCOME | ||
Gain (Loss) on Sale of Assets | 0 | |
Interest Income | 1,000 | |
Total Other Income | 1,000 | |
TAXES | 4,697 | |
Net Income (Loss) | 7,045 |
TASK 2
In this task we are examining the current capital structure of ACME Iron and determining the WACC of the company. Assume that ACMEâs tax rate is 40%.
To compute the WACC you must first find the after-tax cost of debt, the cost of equity and the proportions of debt and equity in the firm. You can assume that the cost of debt before tax is 8% for the firm. Please clearly show how you derive each of these values:
After-tax cost of debt =
Cost of equity =
Proportions of debt and equity in the firm =
How do we compute the WACC in this circumstance? Why do we need to be concerned with the WACC?
Any insights into the capital structure of ACME Iron?
The weighted average cost of capital is the weighted average of the cost of equity and the after-tax cost of debt. Another way of looking at this is computing the effect of the capital structure on expected returns by investors.
WACC= S/B+S x Rs + B/B+S x RB x (1 â tc )
Where
S = value of equity
B = value of debt
Rs = cost of equity
After tax cost of debt: RB x (1 â tc )
Helpful Hint: One thing to bring up here is WACC is needed to determine risk on several levels. To determine risk we need to remember the following items:
1. Risk is deviation from expectations.
2. We need to set expectations for our investments in relation to risk and return. Higher risk = higher return.
3. Capital is obtained from the marketplace in two forms; equity and debt. This is the capital structure of a corporation and impacts the profits of a company depending on how this is managed.
4. We use our cost of capital to discount any cash flows from new investments (NPV and IRR analysis).
5. If cost of capital rises then our risk rises and the projects we undertake to increase sales and return to our investors is reduced.
6. If debt rises then our obligation to make payments on interest increases and profits can decrease if sales do not increase rapidly enough.
7. If risk increases our beta will increase to show the increase in risk. This will increase our required rate of return to stockholders (CAPM) and thus increase our required rate of return we must use in discounting future cash flows.
TASK 3
Acme is planning construction of a new loading ramp for its single iron mill. The initial cost of the investment is $1 million. Efficiencies from the new ramp are expected to reduce costs by $100,000 for the life of the plant which is currently estimated at another 30 years.
When will this project break-even on a simple cash basis and a discounted cash basis.
What is the NPV of the project if Acme has an after tax cost of debt of 8% and a cost equity of 12% (they are currently funded equally by debt and equity)?
Helpful Hint: The first step in conducting an NPV analysis is to include all the relevant cash flows. This includes savings from taxes and any expenses directly related to the venture. We reject any project with a negative NPV.