Assignment 1 - MINI CASE: AMGEN CORPORATION
The Amgen Corporation spent several years working on developing a product that can be used to provide a healthy supplement to a variety of food products. The benefits of a new supplement have been cited in studies of the brain, eyes, and the immune system. Unfortunately, it is difficult to consume enough of any one supplement to get the benefits that most consumers demand. To counter this constraint, Amgen Corp. and several competitors have been able to develop a similar product with various benefits. However, none have been able to produce the "ultimate" solution.
Amgen Corp.'s initial product was designed to supply additives to dairy products and yogurt. For example, the venture's new product was added to cottage cheese and fruit-flavored yogurts to enhance the health benefits of those products. After the long product development period, Amgen Corp. began operations in 2014. Income statement and balance sheet results for 2015, the first full year of operations, have been prepared.
Amgen Corp., however, is concerned with forecasting its financial statements for next year because it is uncertain as to the amount of additional financing of assets that will be needed as the venture ramps up sales next year. Amgen Corp. expects to introduce a new product that offers the taste of chocolate candies. Not only will consumers get the satisfaction of the taste of chocolate candies they will benefit from the vitamin enhancement. What are considered to be conservative, sales are expected to increase 15 percent next year (2016) even though the new product will come on line in mid-year. An additional 20 percent increase in sales is expected the following year (2017), 10 percent in (2018), 5 percent in (2019), before leveling off to a projected future annual growth rate of 3 percent beginning with (2020).
AMGEN CORPORATION - Income Statement for December 31, 2015 (Thousands of Dollars)
Sales $15,000
Operating expenses -12,000
EBIT 3,000
Interest 320
EBT 2,680
Taxes (40%) 1,072
Net income 1,608
Cash dividends (40%) 643
Added retained earnings $965
AMGEN CORPORATION - Balance Sheet as of December 31, 2015 (Thousands of Dollars)
Cash & marketable securities $ 1,000 Accounts payable $ 1,600
Accounts receivable 2,000 Bank Loan 1,800
Inventories 2,200 Accrued liabilities 1,200
Total current assets 5,200 Total current liabilities 4,600
Long-term debt 2,200
Fixed assets, net 6,800 Common stock 2,400
Total assets $12,000 Retained earnings 2,800
Total liabilities & equity $12,000
A. Estimate the additional funds needed (AFN) for 2016, using the formula method based on "percent of sales" relationships.
B. Estimate the AFN for AMGEN for 2017.
C. Prepare pro forma income and balance sheet statements for 2016 before obtaining any additional financing. Why does the AFN from the spreadsheet projections differ from the AFN estimated in Part A?
D. Prepare a second iteration of your pro forma financial statements for 2016 if the initial AFN estimate is to be financed by additional long-term funds at an 8 percent interest rate.
E. Prepare pro forma financial statements for 2017 that build on to the pro forma results obtained in Part D.
F. Prepare projected income statements, balance sheets, and statements of cash flow for AMGEN for 2016 and 2017 before obtaining of any additional financing. What are the amounts of additional funds needed?
G. Assume that sales are expected to grow 10 percent percent in 2018 (over the 2017sales level), 5 percent in 2019, and 3 percent in 2020. Extend your projected financial statements prepared in Part E to include year's 2018, 2019, and 2020. What will be the maximum amount of additional funds needed during your five-year forecast?
H. Assume that you will acquire the amount funds needed in Part F by selling or issuing more common stock and by borrowing from lenders at an 8 percent interest rate. Prepare a second round of projected five-year financial statements showing that the initial financing needed will be obtained equally each year by issuing new stock (50 percent) and by borrowing from lenders (50 percent).
Assignment 2 -
Part A-
1. ABC Corp.'s projected capital budget is $2,000,000, its target capital structure is 60% debt & 40% equity and its forecast net income is $600,000. If the company follows a residual dividend policy, what is the amount of total dividends in dollars and percentage, will it pay out?
2. Collins Company projects the following data for the coming year. If the firm follows the residual dividend policy AND maintains its current target capital structure, what will its payout ratio be?
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EBIT
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$2,000,000
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Capital Budget
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$850,000
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|
Interest rate
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10%
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%Debt/%Equity
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40%/60%
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|
Debt outstanding
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$5,000,000
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Taxes
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40%
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3. What is considered the primary factor that determines a firm's dividend policy?
Part B -
1. Assume you have just been hired as a business manager of Pizza Palace, a regional pizza restaurant chain. The company's EBIT was $50 million last year and is not expected to grow. The firm is currently financed with all equity and it has 10 million shares outstanding. When you took your corporate finance course, your instructor stated that most firms' owners would be financially better off if the firms used some debt. When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firm's investment banker the following estimated costs of debt for the firm at different capital structures:
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% Financed With Debt
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rd
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0%
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---
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|
20
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8.0%
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|
30
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8.5
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40
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10.0
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50
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12.0
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If the company were to recapitalize, debt would be issued, and the funds received would be used to repurchase stock. Pizza Palace is in the 40 percent state-plus-federal corporate tax bracket, its beta is 1.0, the risk-free rate is 6 percent, and the market risk premium is 6 percent.
a. Using the free cash flow valuation model, show the only avenues by which capital structure can affect value.
b. (1) What is business risk? What factors influence a firm's business risk?
b. (2) What is operating leverage, and how does it affect a firm's business risk? Show the operating breakeven point if a company has fixed costs of $200, a sales price of $15, and variables costs of $10.
c. Now, to develop an example which can be presented to Pizza Palace's management to illustrate the effects of financial leverage, consider two hypothetical firms: Firm U, which uses no debt financing, and Firm L, which uses $10,000 of 12 percent debt. Both firms have $20,000 in assets, a 40 percent tax rate, and an expected EBIT of $3,000.
1. Construct partial income statements, which start with EBIT, for the two firms.
2. Now calculate ROE for both firms.
3. What does this example illustrate about the impact of financial leverage on ROE?
d. Explain the difference between financial risk and business risk.
e. What happens to ROE for Firm U and Firm L if EBIT falls to $2,000? What does this imply about the impact of leverage on risk and return?
f. What does capital structure theory attempt to do? What lessons can be learned from capital structure theory? Be sure to address the MM models.
g. What does the empirical evidence say about capital structure theory? What are the implications for managers?
h. With the above points in mind, now consider the optimal capital structure for Pizza Palace.
(1). For each capital structure under consideration, calculate the levered beta, the cost of equity, and the WACC.
(2) Now calculate the corporate value.
i. Describe the recapitalization process and apply it to Pizza Palace. Calculate the resulting the value of the debt that will be issued, the resulting market value of equity, the price per share, the number of shares repurchased, and the remaining shares. Considering only the capital structures under analysis, what is Pizza Palace's optimal capital structure?
Attachment:- Assignment 1.rar