Question 1
The balance sheet that follows indicates the capital structure for Nealon Inc. Flotation costs are (a) 15 percent of market value for a new bond issue, and (b) $2.01 per share for preferred stock. The dividends for common stock were $2.50 last year and are projected to have an annual growth rate of 6 percent. The firm is in a 34 percent tax bracket. What is the weighted average cost of capital if the firm's finances are in the following proportions? Type of financing % of future financing Bonds (8%, $1000 par, 16-yr mat) 38% Preferred stock (5,000 shares outstanding, $50 par, $1.50 dividend) 15% Common equity 47% Total 100% a. Market prices are $1,035 for bonds, $19 for preferred stock, and $35 for common stock. There will be sufficient internal common equity funding (i.e., retained earnings) available such that the firm does not plan to issue new common stock. Calculate the firm's weighted average cost of capital using Excel. b. In part a we assumed that Nealon would have sufficient retained earnings such that it would not need to sell additional common stock to finance its new investments. Consider the situation now, when Nealon's retained earnings anticipated for the coming year are expected to fall short of the equity requirement of 47 percent of new capital raised. Consequently, the firm foresees the possibility that new common shares will have to be issued. To facilitate the sale of shares, Nealon's investment banker has advised management that they should expect a price discount of approximately 7 percent, or $2.45 per share. What is Nealon's cost of equity capital when new shares are sold, and what is the weighted average cost of the added funds involved in the issuance of new shares? Please use Excel to calculate.
Question 2
Use the following to answer questions 21-24: Information on the actual sales and inventory purchases of the Law Company for the first quarter follow: Inventory Sales Purchases January $120,000 $60,000 February $100,000 $78,000 March $130,000 $90,000 Collections from Law Company's customers are normally 60% in the month of sale, 30% in the month following sale, and 8% in the second month following sale. The balance is uncollectible. Law Company takes full advantage of the 3% discount allowed on purchases paid for by the end of the following month. The company expects sales in April of $150,000 and inventory purchases of $100,000. Operating expenses for the month of April are expected to be $38,000, of which $15,000 is salaries and $8,000 is depreciation. The remaining operating expenses are variable with respect to the amount of sales in dollars. Those operating expenses requiring a cash outlay are paid for during the month incurred. Law Company's cash balance on March 1 was $43,000, and on April 1 was $35,000. The expected cash collections from customers during April would be: a. $150,000. b. $137,000. c. $139,000. d. $117,600. Save Answer 22. (Points: 1) The expected cash disbursements during April for inventory purchases would be: a. $100,000. b. $97,000. c. $90,000. d. $87,300. Save Answer 23. (Points: 1) The expected cash disbursements during April for operating expenses would be: a. $38,000. b. $30,000. c. $23,000. d. $15,000. Save Answer 24. (Points: 1) The expected cash balance on April 30 would be: a. $54,700. b. $62,700. c. $19,700. d. $28,700.
Question 3
To demonstrate your ability to apply financial analysis concepts and techniques, complete the following problems from your textbook and include written responses with each as directed: ? Problem 23-2, "Futures" from Chapter 23, page 926. Explain how various types of derivatives, such as futures contracts, can be used as a risk management tool. ? Problem 17-5, "Currency Appreciation" from Chapter 17, page 726. Explain factors that can affect the appreciation or depreciation of currency. Provide full documentation of the process used to reach the solution. Use information from the textbook to inform your analysis, incorporating creativity, critical thinking, and real-life perspectives. Since the purpose of any real work is sharing and using the results, keep in mind that a thorough, professional presentation of your analysis and results is important. Complete the Unit 6 problem spreadsheet template provided below and submit in the assignment area. (17.5). Suppose that I Swiss Franc could be purchased in the foreign exchange market for 60 U.S. cents today. If the franc appreciated 10% tomorrow against the dollar, how many francs would a dollar buy tomorrow? Explain factors that can affect the appreciation or depreciation of currency. (23.2). A Treasury bond futures contract has a settlement price of 89?08. What is the implied annual yiels? Explain how various types of derivatives, such as futures contracts, can be used as a risk management tool.
Question 4
1. (TCO A) Bentley Corporation has several divisions. All operations keep their own accounting books and have chosen the appropriate method of revenue recognition. Information on Divisions: Bargain Electronics Division Bargain Electronics Division sells computers through agents in various cities. Revenue is recognized at the point of sales. Agents send orders and down payments to our company. The division then ships the goods F.O.B. shipping point directly to the customers. Additional Financial Data: Orders for fiscal year 2012 $1,800,000 Down Payments collected in 2012 $240,000 Billed and shipped in 2012 $1,600,000 Freight billed in 2012 $50,000 Commissions paid to Agents (after ship to customer) 10% Warranty Returns as % of Sales 1% Barry's Construction Division The Barry Construction Division was working on one project and used the percentage of completion revenue recognition method for 2012 fiscal year. Contract for new retail mall building Total Contract Amount $85,000,000 Contract Grant Date August 14, 2012 Construction Began September 1, 2012 Estimated Cost to Complete at beginning of contract $62,000,000 Estimated Time to Complete Project 2 years As of December 31, 2012 Construction costs incurred to date $11,500,000 Billings to date $20,000,000 Expected costs to complete $34,500,000 Bead's Magazine Distribution Division Our magazine distribution division sells to national quickmart stores. Our division allows for up to 25% of sales in returns. For the past 4 years, returns have averaged 22%. We record revenue based on revenue recognition when the right of return exists. Total Sales for 2012 $9,000,000 Sales Still Available for return for six months $2,400,000 Actual Returns on Sales not returnable 22% 2011 Sales collected in 2012 $500,000 2011 Sales returned in 2012 23% Required: Calculate the revenue to be recognized in fiscal year 2012 for each division of Bentley Corporation in accordance with generally accepted accounting principles. Show all calculations for full credit.
Question 5
Shareholder Value Analysis Notes & Exercise Shareholder Value Analysis (SVA) is one member of the family of techniques for determining the market value of a firm based on the drivers of its projected cash flows. Other cash-based techniques include Cash Flow Return on Investment (CFROI) and Total Shareholder Return (TSR). SVA is superior to other techniques because valuations are derived from explicitly identified drivers of value in a strategic framework. SVA starts with fundamental financial theory: the value of an asset is the net present value of its cash flows over the life of the asset. In SVA, the firm is the asset to be valued/assessed. One then identifies the drivers of firm cash flows over the life of the firm and integrates the drivers into a model, which generates the estimated free cash flows on a year-by-year basis. Let's look at the drivers of cash/value. 1. Sales growth rate: Everything else being constant, the higher the sales growth rate, the greater the projected cash flows. 2. Operating profit margin: The higher the profit margin (sales - cash operating expenses), the greater the cash flows. 3. Tax rate: The higher the tax rate, the lower the net cash flow. 4. Working capital investment: Increased sales require greater investments in working capital (inventories, cash, receivables, offset by simultaneous financing provided by accounts payable and accruals), which decrease cash flows accordingly. 5. New Fixed capital investment: An expansion (growth in sales) of the business requires a larger base of fixed capital investments, which will decrease cash flows. This is equivalent to total projected capital investment for the year less depreciation. 6. Competitive advantage period: In a perfectly competitive market there are no superior profits to be had, given that all firms must price at marginal cost if they want to make sales. However, by making use of technology, positioning oneself in emerging or high growth industries, through superior customer service/relationship management and by developing a differentiated or niche product, firms will be able to set prices above marginal costs. Firms strive to achieve competitive advantage and thus the flexibility to sell at higher prices and realize higher profit margins. The more a firm is able to exploit a competitive advantage and maintain it over time, the more successful it will be and the higher its cash flows. The competitive advantage period affects the estimate of the sales growth rate and the cash profit margin over time. For example, an analysis of Microsoft's core competencies and its ability to develop and maintain competitive advantage over time could provide the basis estimation g at 20% per year for the next five years, 15% per year for years 6-10 and then leveling out after year 10. The cash profit margin would reflect the loss of superior competitive advantage over time accordingly, perhaps being estimated at 35% for years 1-5, 25% for years 6-10 and 10% after year 10. The greater the competitive advantage, the greater the cash flows and the calculated shareholder value. 7. Cost of capital: The cost of capital represents the expectations of stakeholders (stock and bondholders). When the firm earns more on its assets than expected/required by stakeholders, value is created for shareholders. The management actions taken by the firm have an effect on the firm's cost of capital and, the lower the cost of capital, the greater the (net present) value of the firm. Management would be able to decrease the firm's cost of capital and create shareholder value by financing the firm's capital structure with the optimal proportion of debt and by identifying ways to decrease the systematic risk of the firm's investments. Model: Firm Value = PV free cash flows over the forecast period + residual value beyond the forecast period + firm's marketable securities. 1. PV free cash flows over the forecast (competitive advantage) period = Base sales * sales growth * cash profit margin * after-tax cash income rate - new capital investment - incremental working capital investment to support increased sales, over the period that the company is projected to maintain a competitive advantage. Expected cash flows are calculated for each year of the forecast (competitive advantage) period and discounted by the cost of capital. In the Microsoft example above, the forecast (competitive advantage) period of cash flows would be years 1-5 and years 6-10. 2. Residual value after the forecast (competitive advantage) period has expired and the firm's sales and earnings level out: The present value of cash flows after expiration of competitive advantage (sales and earnings levels are constant, or no growth). After some period, the ability of the firm to achieve growing sales and high profit margins will dissipate, after competitors enter the market and provide the same level of differentiation. At this point no incremental capital investments or additional investments in working capital are required; only maintenance-level investments are required. The expected cash flows are the same each year after the competitive advantage period, or perpetuity. The present value of a perpetuity, you will recall, is just the expected cash flow divided by the discount rate/cost of capital for a no growth perpetuity, or by the cost of capital less the constant growth rate for a growth perpetuity. 3. The firm's marketable securities: We add marketable securities because 1 & 2 above represent the value generated by investments in the business. Marketable securities guarantee liquidity in contingencies and are not considered an investment in the firm's income generating assets. Work through the model to understand the relationships amongst the value drivers and how the model is used to derive the estimate for firm value. The model provides flexibility by allowing the analyst to 'tweak' the driver values to fit the specific situation for the firm being analyzed. If we want to derive the value of equity, we can simply subtract the market value of the firm's debt from Firm Value, which is the sum of 1, 2, and 3 above (Equity value = Firm Value - Debt). We can then compare the 'fair value' of equity we derived using SVA with the market value equity (# shares outstanding * price per share) to obtain an indication of whether the firm is under- or over-valued. The use of the SVA methodology developed by Rappaport extends far beyond a technique for estimating the value of the firm. It is the integration of SVA valuation methodology into a strategic context that makes it especially useful to managers. SVA can be used to evaluate strategic alternatives: Which ones add value? What can be done to create value? How can we extend the competitive advantage period and keep profit margins high? The same answers we arrive at in building a world class strategic plan are the same ones supporting the creation of shareholder wealth in the SVA model. Do the following SVA Exercise: The following information is given: * Baseline (last year) sales: $200 million * Sales growth rates: Base year = 15% with a fade rate of 1% a year for years 1-10: (increasing sales due to sustained competitive advantage and a differentiated product)[source: Strategic Plan]. Fade rate is the rate of decline per year from a base year. * Sales growth rate in year 10 and forward: 5% (in year 11, the competition has caught up and the market has reached maturity) [source: Strategic Plan] * Profit margin: Base year = 20%, with a fade rate of 1% a year for years 1-10: (during the period of competitive advantage, the firm can charge higher prices, but its profit margin slowly declines as competition increases) [source: Strategic Plan] * Profit margin in year 10 and going forward: 10% [source: Strategic Plan] * Fixed capital investment rate: 20% (for every dollar of new sales, we need an additional investment in fixed plant & equipment of $.20) [source: historical relationship] * Working capital investment rate: 5% (for every dollar of new sales we need an additional investment in inventories & receivables of $.05) [source: historical relationship] * Cash tax rate: 40% [source: historical relationship] * Cost of capital: 11% [source: current yield on firm's debt & the cost of equity estimated using the Capital Asset Pricing Model, weighted average based on the target capital structure] * Marketable securities: $15 million * Market value of firm's debt: $50 million * The firm has 5 million shares of common stock outstanding selling at: **scenario 1 = $40/share and **scenario 2 = $60/share. As indicated, the values assigned to drivers link directly to the strategic plan and the associated strategic analysis. In arriving at these estimates strategic alternatives have been evaluated for their value creation potential, with the set of strategies selected that create the most shareholder wealth. 1. What is the PV of operating cash flows over the competitive advantage period? 2. What is the residual value of the firm after the period of competitive advantage? 3. What is the value of the firm's equity? 4. Compare the market value of equity ($40/share) with the estimate provided by SVA for scenario 1. What recommendations would you make to top management based on your analysis? Now compare the market value of equity ($60/share) with your SVA estimate. What would you recommend now?
