You are asked to answer all the questions in the proposed two cases.
This task assesses the following:
• Critically understand advanced theories and principles of Finance
• Discuss and critically evaluate the finance definitions/terms used in contemporary business.
• Contrast and appraise different sources of finance and their appropriateness, evaluate the implications for managers and investors.
Submission file format: Word document with all the answers, clearly identifying both cases separately.
CASE 1 (50 points)
You have been hired as a consultant for Medicals Inc., manufacturer of medical devices. The company projects unit sales for a new dental implant as follows:
Year Unit Sales
1 73,000
2 86,000
3 97,000
4 68,000
• Production of the implants will require $1,500,000 in net working capital immediately, all of which will be recovered at the end of the project.
• Total fixed costs are $4,200,000 per year, variable production costs are $255 per unit, and the units are priced at $375 each.
• The equipment needed to begin production has an installed cost of $8,500,000. This equipment qualifies as three-year MACRS property (depreciation rates are 33.33% for Year 1, 44.45% for Year 2, 14.81% for Year 3, and 7.41% for Year 4).
• In four years, this equipment can be sold for about 20 percent of its acquisition cost.
• The tax rate is 21 percent and the required return is 24 percent.
• The company imposes a payback cutoff of three years for its investment projects.
QUESTIONS:
1. Complete the pro forma and determine total cash flows for each year of project’s life. (20 points)
Understanding the case and the process 10 points, finding the right cash flow 10 points (2 per year)
2. Calculate the following investment criteria for the project:
(a) Payback period (5 points) (2.5 for the right formula/approach and 2.5 for the right result)
(b) Profitability Index (PI) (5 points) (2.5 for the right formula/approach and 2.5 for the right result)
(c) Internal rate of return (IRR) (5 points) (2.5 for the right formula/approach and 2.5 for the right result)
(d) Net Present Value (NPV) (5 points) (2.5 for the right formula/approach and 2.5 for the right result)
3. Explain your decision whether you recommend accepting or rejecting the project. (10 points) (3 points for the right answer and 7 points for the explanation)
Year 0 1 2 3 4
Sales revenues
Variable Costs
Fixed Costs
Depreciation
EBIT
Taxes
Net income
Operating Cash Flow
Capital spending
Net Working Capital
After-tax salvage value
Total Cash Flow
CASE 2 (50 points)
You have recently been hired by Falcon Motors, Inc. (FMI) located in Denver USA, in its relatively new treasury management department. FMI was founded eight years ago by Joe Falcon. Joe found a method to manufacture a cheaper battery that will hold a larger charge, giving a car powered by the battery a range of 700 miles before requiring a charge. The cars manufactured by FMI are midsized and carry a price that allows the company to compete with other mainstream auto manufacturers. The company is privately owned by Joe and his family, and it had sales of $97 million last year.
FMI primarily sells to customers who buy the cars online, although it does have a limited number of company-owned dealerships. The customer selects any customization and makes a deposit of 20 percent of the purchase price. After the order is taken, the car is made to order, typically within 45 days. FMI’s growth to date has come from its profits. When the company had sufficient capital, it would expand production. Relatively little formal analysis has been used in its capital budgeting process. Joe has just read about capital budgeting techniques and has come to you for help. For starters, the company has never attempted to determine its cost of capital, and Joe would like you to perform the analysis. Because the company is privately owned, it is difficult to determine the cost of equity for the company. Joe wants you to use the pure play approach to estimate the cost of capital for FMI, and he has chosen Tesla Motors as a representative company. The following questions will lead you through the steps to calculate this estimate.
QUESTIONS:
1. Most publicly traded corporations are required to submit quarterly (10-Q) and annual (10-K) reports to the SEC detailing the financial operations of the company over the past quarter or year, respectively. These corporate filings are available on the SEC website at www.sec.gov. Go to the SEC website, follow the “Search for Company Filings” link, and search for SEC filings made by Tesla Motors (TSLA). Find the most recent 10-Q or 10-K, and download the form. Look on the balance sheet to find the book value of debt and the book value of equity. (10 points) (5 points for finding the data, 2.5 points for book value of debt and 2.5 points for book value of equity)
2. To estimate the cost of equity for TSLA, go to finance.yahoo.com and enter the ticker symbol TSLA. Follow the links to answer the following questions: What is the most recent stock price listed for TSLA? What is the market value of equity, or market capitalization? How many shares of stock does TSLA have outstanding? What is the most recent annual dividend? Can you use the dividend discount model in this case? What is the beta for TSLA? Now go back to finance.yahoo.com and follow the “Bonds” link. What is the yield on three-month Treasury bills? Using the historical market risk premium, what is the cost of equity for TSLA using CAPM? (10 points) (1 point per each of the first 8 questions and 2 points for cost of Equity using CAPM)
3. You now need to calculate the cost of debt for TSLA. Go to finra-markets.morningstar.com, enter TSLA as the company, and find the yield to maturity for each of TSLA’s bonds. What is the weighted average cost of debt for TSLA using the book value weights and using the market value weights? Does it make a difference in this case if you use book value weights or market value weights? (10 points) (3 points for Book Value weighted cost of Debt, 3 points for weighted average market value 4 points for the argument)
4. You now have all the necessary information to calculate the weighted average cost of capital for TSLA. Calculate this using book value weights and market value weights, assuming TSLA has a 21 percent tax rate. Which number is more relevant? (10 points) (3 points for WACC calculation at book value, 3 points for WACC using market value weights, 4 points for the argument)
5. You used TSLA as a pure play company to estimate the cost of capital for FMI. Are there any potential problems with this approach in this situation? (10 points)
Rubrics
Descriptor
9-10 The student demonstrates an excellent understanding of the concepts.
8-8.9 The student demonstrates a good understanding of the concepts.
7-7.9 The student demonstrates a fair understanding of the concepts.
6-6.9 The student demonstrates some, but insufficient understanding of the concepts.
3-5.9 The student demonstrates insufficient understanding of the concepts. They may mention some relevant ideas or concepts, although it is clear that the relationship between them is not understood by the student.
1-2.9 The student demonstrates insufficient understanding of the concepts and does not mention any relevant ideas or concepts.
0 The student leaves the question blank or cheats.
Points are at the end of each question.