MGMT SB102- Final Exam Guide - Comprehensive Notes for the exam ( 24 pages long!)
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Capital Budgeting Group Presentation Project
Instructions: This project requires you to apply the concepts and methods learned in the course. This is a group project.
Assignment: You are interested in proposing a new venture (Project I) to the management of your company. Pertinent financial information is given below.
Balance Sheet Data
Cash | 3,000,000 | Accounts Payable and Accruals | 14,000,000 |
Accounts Receivable | 24,000,000 | Notes Payable | 41,000,000 |
Inventories | 45,000,000 | Long-Term Debt | 50,000,000 |
Preferred Stock | 20,000,000 | ||
Net Fixed Assets | 128,000,000 | Common Equity | 75,000,000 |
Total Assets | 200,000,000 | Total Liabilities & Ownersâ Equity | 200,000,000 |
Last yearâs sales were $210,000,000.
The company has 60,000 bonds with a 30-year life outstanding, with 15 years until maturity. The bonds carry a 9 percent semi-annual coupon, and are currently selling for $870.73.
You also have 100,000 shares of perpetual preferred stock outstanding, which pays a dividend of $7.80 per share. The current market price is $94.00.
The company has 10 million shares of common stock outstanding with a current price of $15.00 per share. The stock exhibits a constant growth rate of 8 percent. The last dividend (D0) was $.90.
Your firm does not use notes payable for long-term financing.
The firmâs target capital structure is 25% debt, 5% preferred stock, and 70% common equity. The firm does not plan to issue new common stock.
Your firmâs federal + state marginal tax rate is 38%.
The firm has the following investment opportunities currently available in addition to the venture that you are proposing:
Project | Cost | IRR |
A | 17,000,000 | 21% |
B | 21,000,000 | 19% |
C | 16,000,000 | 15% |
D | 28,000,000 | 11% |
E | 25,000,000 | 8% |
All projects, including Project I, are assumed to be of average risk. Your venture would consist of a new product introduction (You should label your venture as Project I, for âintroductionâ). You estimate that your product will have a six-year life span, and the equipment used to manufacture the project falls into the MACRS 5-year class. The resulting MACRS depreciation percentages for years 1 through 6, respectively, are 20%, 32%, 19%, 12%, 11%, and 6%. Your venture would require a capital investment of $17,000,000 in equipment, plus $1,000,000 in installation costs. The venture would also result in an increase in accounts receivable and inventories of $1,000,000 (value at the end of year 6). At the end of the six-year life span of the venture, you estimate that the equipment could be sold at a $5,000,000 salvage value. Your venture would incur fixed costs of $1,000,000 per year, while the variable costs of the venture would equal 30 percent of revenues. You are projecting that revenues generated by the project would equal $6,000,000 in year 1, $14,000,000 in year 2, $15,000,000 in year 3, $16,000,000 in year 4, $11,000,000 in year 5, and $8,000,000 in year 6.
The following list of steps provides a structure that you should use in analyzing your new venture. Note: Carry all final calculations to two decimal places.
1. Find the costs of the individual capital components (15 points):
a. long-term debt
b. preferred stock
c. retained earnings (use DCF approach)
2. Determine the weighted average cost of capital. (5 points)
3. Compute the Year 0 investment for Project I. (5 points)
4. Compute the annual operating cash flows for years 1-6 of the project. (20 points)
5. Compute the non-operating (terminal) cash flow at the end of year 6. (10 points)
6. Draw a timeline that summarizes all of the cash flows for your venture. (5 points)
7. Compute the IRR, payback, discounted payback, and NPV for Project I. (20 points)
8. Prepare a report for the firmâs CEO indicating which projects should be accepted and why. (45 points)
9. Conclude the project with your reflections on what you have learned from this course and how it has affected your view of your own job and career. (45 points)
10. A 15-20 minute presentation will report out on items 1-9. (65 pts.)
Please Note: Complete the capital budgeting group project according to the instructions contained in the syllabus, and upload all documentation and calculations into this assignment folder. There will be only one submission per group, and submitter will be chosen by the group. Please let the instructor know who will be submitting the group project to Moodle.
You are proposing a new venture, to branch out into animals and cartoon characters but this will require some new equipment and a capital outlay. Pertinent financial information is given below.
BALANCE SHEET
Cash | 2,000,000 | Accounts Payable and Accruals | 18,000,000 |
Accounts Receivable | 28,000,000 | Notes Payable | 40,000,000 |
Inventories | 42,000,000 | Long-Term Debt | 60,000,000 |
Preferred Stock | 10,000,000 | ||
Net Fixed Assets | 133,000,000 | Common Equity | 77,000,000 |
Total Assets | 205,000,000 | Total Claims | 205,000,000 |
� Last year�s sales were $225,000,000.
� The company has 60,000 bonds with a 30-year life outstanding, with 15 years until maturity. The bonds carry a 10 percent annual coupon, and are currently selling for $874.78.
� You also have 100,000 shares of $100 par, 9% dividend perpetual preferred stock outstanding. The current market price is $90.00. Any new issues of preferred stock would incur a $3.00 per share flotation cost.
� The company has 10 million shares of common stock outstanding with a currently price of $14.00 per share. The stock exhibits a constant growth rate of 10 percent. The last dividend (D0) was $.80. New stock could be sold with 15% flotation costs.
� The risk-free rate is currently 6 percent, and the rate of return on the stock market as a whole is 14 percent. Your stock�s beta is 1.22.
� Stockholders require a risk premium of 5 percent above the return on the firms bonds.
� The firm expects to have additional retained earnings of $10 million in the coming year, and expects depreciation expenses of $35 million.
� Your firm does not use notes payable for long-term financing.
� The firm considers its current market value capital structure to be optimal, and wishes to maintain that structure. (Hint: Examine the market value of the firm�s capital structure, rather than its book value.)
� The firm is currently using its assets at capacity.
� The firm�s management requires a 2 percent adjustment to the cost of capital for risky projects.
� Your firm�s federal + state marginal tax rate is 40%.
� Your firm�s dividend payout ratio is 50 percent, and net profit margin was 8.89 percent.
� The firm has the following investment opportunities currently available in addition to the expansion you are proposing:
Project | Cost | IRR |
A | 10,000,000 | 20% |
B | 20,000,000 | 18% |
C | 15,000,000 | 14% |
D | 30,000,000 | 12% |
E | 25,000,000 | 10% |
Your expansion would consist of a new product introduction (You should label your venture as Project I, for �introduction�). You estimate that your product will have a six-year life span (after all how many people will really buy this stuff), and the equipment used to manufacture the project falls into the MACRS 5-year class. Your venture would require a capital investment of $15,000,000 in equipment, plus $2,000,000 in installation costs. The venture would also result in an increase in accounts receivable and inventories of $4,000,000. At the end of the six-year life span of the venture, you estimate that the equipment could be sold at a $4,000,000 salvage value.
Your venture, which management considers fairly risky, would increase fixed costs by a constant $1,000,000 per year, while the variable costs of the venture would equal 30 percent of revenues. You are projecting that revenues generated by the project would equal $5,000,000 in year 1, $10,000,000 in year 2, $14,000,000 in year 3, $16,000,000 in year 4, $12,000,000 in year 5, and $8,000,000 in year 6.
The following list of steps provides a structure that you should use in analyzing your new venture.
Note: Carry all final calculations to two decimal places.
Find the WACC:
1. Find the costs (rate of return under current market conditions) of the individual capital components:
a. long-term debt (Hint: PV=-$874.78, FV = $1000, PMT=$100, n=15 solve for i)
b. preferred stock
c. retained earnings (avg. of CAPM and bond yield + risk premium approaches)
d. new common stock
2. Compute the value of the long-term elements of the capital structure, and determine the target percentages for the optimal capital structure. (Carry weights to four decimal places. For example: 0.2973 or 29.73%)
Find the Cash Flow from the project:
3. Compute the Year 0 investment for Project I.
4. Compute the annual operating cash flows for years 1-6 of the project.
5. Compute the additional non-operating cash flow at the end of year 6.
Find alternative capital budgeting measures:
6. Compute the IRR and payback period for Project I.
7. Determine your firm�s cost of capital. (Hint this is the WACC plus an adjustment from the write up)
Make Some Decisions:
8. Compute the NPV for Project I. Should management adopt this project based on your analysis? Explain. Would your answer be different if the project were determined to be of average risk? Explain.
9. Indicate which of the other projects (A through E) should be accepted and why.
(If possible can you please complete in an excel document)
Excel Project Instructions
Assume ABC Company has asked you to not only prepare their 2015 year-end Balance Sheet but to also provide pro-forma financial statements for 2016. In addition, they have asked you to evaluate their company based on the pro-forma statements with regard to ratios. They also want you to evaluate 3 projects they are considering. Their information is as follows:
End of the year information:
Account | 12/31/15 Ending Balance |
Cash | 50,000 |
Accounts Receivable | 175,000 |
Inventory | 126,00 |
Equipment | 480,000 |
Accumulated Depreciation | 90,000 |
Accounts Payable | 156,000 |
Short-term Notes Payable | 12,000 |
Long-term Notes Payable | 200,000 |
Common Stock | 235,000 |
Retained Earnings | solve |
Additional Information:
Sales for December total 10,000 units. Each monthâs sales are expected to exceed the prior monthâs results by 5%. The productâs selling price is $25 per unit.
Company policy calls for a given monthâs ending inventory to equal 80% of the next monthâs expected unit sales. The December 31 2015 inventory is 8,400 units, which complies with the policy. The purchase price is $15 per unit.
Sales representativesâ commissions are 12.5% of sales and are paid in the month of the sales. The sales managerâs monthly salary will be $3,500 in January and $4,000 per month thereafter.
Monthly general and administrative expenses include $8,000 administrative salaries, $5,000 depreciation, and 0.9% monthly interest on the long-term note payable.
The company expects 30% of sales to be for cash and the remaining 70% on credit. Receivables are collected in full in the month following the sale (none is collected in the month of sale).
All merchandise purchases are on credit, and no payables arise from any other transactions. One monthâs purchases are fully paid in the next month.
The minimum ending cash balance for all months is $50,000. If necessary, the company borrows enough cash using a short-term note to reach the minimum. Short-term notes require an interest payment of 1% at each month-end (before any repayment). If the ending cash balance exceeds the minimum, the excess will be applied to repaying the short-term notes payable balance.
Dividends of $100,000 are to be declared and paid in February.
No cash payments for income taxes are to be made during the first calendar quarter. Income taxes will be assessed at 35% in the quarter.
Equipment purchases of $55,000 are scheduled for March.
ABC Companyâs management is also considering 3 new projects consisting of the purchase of new equipment. The company has limited resources, and may not be able to complete make all 3 purchases. The information is as follows for the purchases below.
Project 1 | Project 2 | Project 3 | |
Purchase Price | $80,000 | $175,000 | $22,700 |
Required Rate of Return | 6% | 8% | 12% |
Time Period | 3 years | 5 years | 2 years |
Cash Flows â Year 1 | $48,000 | $85,000 | $15,000 |
Cash Flows â Year 2 | $36,000 | $74,000 | $12,000 |
Cash Flows â Year 3 | $22,000 | $38,000 | N/A |
Cash Flows â Year 4 | N/A | $26,800 | N/A |
Cash Flows â Year 5 | N/A | $19,000 | N/A |
Required Action:
Part A:
Prepare the year-end balance sheet for 2015. Be sure to use proper headings.
Prepare budgets such that the pro-forma financial statements for the first quarter of 2016 may be prepared.
Sales budget, including budgeted sales for April.
Purchases budget, the budgeted cost of goods sold for each month and quarter, and the cost of the March 31 budgeted inventory.
Selling expense budget.
General and administrative expense budget.
Expected cash receipts from customers and the expected March 31 balance of accounts receivable.
Expected cash payments for purchases and the expected March 31 balance of accounts payable.
Cash budget.
Budgeted income statement.
Budgeted statement of retained earnings.
Budgeted balance sheet.
Part B:
Calculate using Excel formulas, the NPV of each of the 3 projects.
It is possible that ABC Company may not be able to complete all 3 projects. Therefore, advise ABC Company as to the order in which they should pursue the projects (i.e., which project should ABC Company attempt to do first, second, and last).
Provide justification and analysis as to why you chose the order you did. The analysis must also be done in Excel, not in a separate document.