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Question 4 (12 marks)
Phonic Solutions PLC is considering creating a new division, which will require an
investment in computer & telecommunications equipment of $10 million. The
company has a cost of capital of 12%.
The sales department has forecast sales for each of the next five years as follows:
Year 1 $4 million
Year 2 $6 million
Year 3 $8 million
Year 4 $6 million
Year 5 $4 million
Operations staff have predicted the cost of sales as 30% of revenue. Rent and office
expenses are $300,000 each year. Selling and administration salaries will be $400,000
in the first year increasing each year by 5%. Repairs & maintenance will be $100,000
in each of years 1 and 2, $200,000 in each of years 3 and 4, and $300,000 in year 5.
The company depreciates its equipment over 4 years.
a. Produce a
i. Profit budget for each of the five years, showing both gross profit and
operating profit; (2 MARKS)
ii. Cash flow for each of the five years (2 MARKS), and
iii. Apply a discounted cash flow technique and use this to recommend
whether the new division and capital investment should proceed (2
b. What does theory tell us about the strengths and limitations of budgeting and the
discounted cash flow technique? (6 MARKS)
How do financial markets and related institutions contribute to the overall economic health of the economy? Imagine a CFO who believes her job is to focus exclusively on company-level issues and assumes the markets run smoothly and will provide the company with capital as it is needed, assuming it has a good justification for the capital. Is this an advisable strategy? Why or why not
Return on Stock
Question 5 (15 marks)
Suppose Intel stock has a beta of 1.8, whereas Boeing stock has a beta of 1.2. If the risk free interest rate is 5% and the expected return of the market portfolio is 15%, according to the CAPM,
a. What is the expected return of Intel stock?
b. What is the expected return of Boeing stock?
c. What is the beta of a portfolio that consists of 70% Intel stock and 30% Boeing stock?
What is the expected return of a portfolio that consists of 60% Intel stock and 40% Boeing stock?
Project 1 Calculating FCF and ROIC
Use five years Compustat data for your company to compute or find the following for each of the five years:
2. Operating CA
3. Operating CL
5. Net PPE
6. Total Operating Capital
7. Change in TOC
10. Uses of FCF
Use cell references for your computations. Project 1 Format is an example file.
Project 2 Ratio Analysis
Use the five year annual ratio report to identify trends in liquidity, profitability, asset utilization (activity) and debt utilization (leverage).
Prepare a table that shows the ratios for your company’s latest reporting year, compared to the same year for it’s two closest peer companies and the industry average. Identify areas where your company is performing well or needs improvement.
Project 2 Format shows what this table should look like.
Project 3 WACC
For your company find:
1. The capital structure
2. The pre and after tax cost of debt
4. The risk-free rate
5. The market risk premium
6. The cost of equity capital
7. The weighted average cost of capital (WACC).
Define 1 through 7 and identify your sources. Show all calculations. Use the WACC to complete the valuation in Project 4.
Project 4 Forecasting and FCF Valuation
Prepare a spreadsheet forecast of FCFs and a valuation for your company similar to what we did for Chapter 9 Problem 11. Show cell references in your calculations. Chapter 9 Problem 11 spreadsheet is provided as reference.
Question 5 (6 marks)
Lincoln Company developed a product that has been produced and sold between 2003
and 2008. Sales increased over time and then reduced until the product was
abandoned at the end of 2008. Margins and expenses both fluctuated during the
lifecycle of the product. The relevant data from each year’s financial reports are
shown in the following table:
2003 2004 2005 2006 2007 2008
Sales 100,000 120,000 175,000 325,000 300,000 150,000
Gross margin 25% 30% 35% 25% 20% 15%
Expenses 45,000 65,000 30,000 25,000 30,000 30,000
Calculate the product’s profitability each year and over the lifecycle (2 MARKS) and
draw appropriate conclusions (4 MARKS).
Problem 6 (15 marks)
At the beginning of 2013, Apple’s beta was 1.2 and the risk-free was about 3%. Apple’s price was $75. Apple’s price at the end of 2013 was $80. If you estimate the market risk premium to have been 6%, did Apple’s managers exceed their investors’ required return as given by the CAPM? Why? Explain.
Section 1: Equity and debt financing, risk and return, cost of capital
1. How much overall risk is there in the firm? (5 marks)
2. Where is the risk coming from (market risk, industry risk or currency risk)? (5 marks)
3. How is the risk profile changing? (5 marks)
4. What return would you have earned investing in this company’s stock? (5 marks)
5. Would your company’s stock have under or outperformed the market? (5 marks)
6. How much of the performance can be attributed to management? (5 marks)
7. What is its cost of equity? (5 marks)
8. How risky is this company’s debt? (5 marks)
9. What is its cost of debt? (5 marks)
10.What is this company’s current cost of capital? (10 marks)
Section 2: Capital structure choices
1. What are the different kinds or types of financing that this company has used to raise funds? (5 marks)
2. What is the historical debt to equity ratio and debt to total asset ratio for this firm in past 5 years?(5 marks)
3. Explain the advantages and disadvantages associated with the firm using debt? (5 marks)
4. How does the capital structure compare to peers in the industry? From the qualitative trade-off, does this firm look like it has too much or too little debt? (10 marks)
Section 3: Dividend policy
1. How much cash has the firm accumulated over time? (5 marks)
2. How has the company returned cash to its owners? (Has it paid dividends or bought back stock?) (10 marks)
3. How does this firm’s dividend policy compare to those of its peer groups in the industry? (5 marks)
Laxmi Silwal inherited a property from her grandparents few decades ago and since then the value of the property has been gradually increasing. She in planning to sell the property so she can buy a new house by the bay area. She is considering several offers for the property and several saving plans.
(i) The first offer is a single lump sum amount of $600,000 to be received on 1st January 2017. Laxmi will deposit the amount in a savings account in Commonwealth bank earning 4.25% per annum. If she accepts this offer, how much money will she have in her account at the end of 2020? (Round your answer to whole number) (3 mark)
(ii) The second offer is a single lump sum amount of $600,000 to be received on 1st January 2017. Laxmi will deposit the amount in a savings account in Commonwealth bank earning 4% per annum, compounding half yearly. If she accepts this offer, how much money will she have in her account at the end of 2020? (Round your answer to whole number) (3 mark)
(iii) The third offer is a series of four annual payments on 1st January 2017, 2018, 2019 and 2020 of $350,000, $120,000, $100,000 and $50,000. Laxmi will deposit all payments received in a savings account in Commonwealth bank earning 4% per annum. If she accepts this offer how much will she have saved at the end of 2020? Round your answer to whole number) (3 mark)
BBAC602 Group Assignment Page 2
(iv) The fourth offer is a series of four equal annual payments of $140,000 on 1st January 2017, 2018, 2019 and 2020. Laxmi will deposit all payments received in a savings account in Commonwealth bank earning 4% per annum. If she accepts this offer how much will she have saved at the end of 2020? (Round your answer to whole number) (3 mark)
(v) If Laxmi accepts the second offer for 4 years, what is the effective annual rate of return? (Round your answer to two decimal places) (2 marks)
(vi) Which option will Laxmi choose, and why? (1 mark)
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