Topic 1
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The CEO of Southwest Manufacturing Company has asked for your analysis of and recommendation related to the proposed acquisition of an additional stamping machine for its principal manufacturing plant. Demand for the company's products has risen to a level that exceeds its present productive capacity. An additional stamping machine will make it possible for the company to increase its production and sales by 15 percent, resulting in projected incremental relevant cash flows (after income taxes and the tax benefits of the "depreciation tax shield") in each of the next five years, as indicated at right:
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Year
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Projected incremental cash flows
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1
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$20,000
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2
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30,000
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3
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40,000
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4
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30,000
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5
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20,000
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Total
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$140,000
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The equipment will cost $100,000 to purchase and install. Management estimates that its economic life will be five years, after which it will have no residual value. The company's required rate of return on new investments (cost of capital) is 12.0 percent (or, 0.12).
a. Complete the NPV analysis of the stamping machine proposal, below. Regard all incremental relevant cash flows as "risky" and assume they occur at the end of years indicated, as listed above.
b. State your recommendation to the CEO, including the basis for it. Limit the length of your response to 50 words.
Topic 2
The VP-Operations of Southwest Manufacturing Company has asked for your review of her capital budgeting analysis, comparing two alternative machines the company is considering acquiring for one of its plants. Using the information provided in the table below, complete her analysis by computing the company's cost of equity capital, rE, weighted average cost of capital, rWACC, and the equivalent annual cost (EAC) for each machine under consideration. State your recommendation to the VP with regard to selecting one of these machines.
a. Compute the company's cost of equity capital, rE. Show computations in good form and label properly all amounts presented.
b. Compute the company's weighted average cost of capital, rWACC. Show computations in good form and label properly all amounts presented.
c. Compute the equivalent annual cost (EAC) for each machine under consideration, ignoring "cost recovery" income tax deductions, the tax deductibility of ownership costs, and capital gains taxes upon the machine's disposal). Show computations in good form and label properly all amounts presented.
d. State your recommendation to the VP-Operations, including the basis for it. Limit the length of your response to 50 words.
Topic 3
The VP-Sales and Marketing of Southwest Manufacturing Company has asked for your analysis of her proposal to modify the company's current terms of sale, "2/10, net/30." She has proposed more generous terms - "3/5, net/30" - in order to promote increased sales and market share. She has acknowledged that more generous terms may also lead to increased bad debts. The business' operating budget for the forthcoming fiscal year includes the following relevant information:
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Budgeted unit sales, Q1
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5,000,000
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units
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Budgeted unit selling, SP
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$20
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per unit
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Budgeted bad debts, BD1, as percent of sales
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0.01
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(or, 1.0 percent)
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Budgeted unit variable cost, VC (excluding BD1)
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$10
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per unit
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Combined effective income tax rate, t
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0.40
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(or, 40.0 percent)
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Current interest rate on business' debt, rD
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0.12
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(or, 12.0 percent)
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In addition, based on the existing terms of sales:
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Discount percentage, CD1
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0.02
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(or, 2.0 percent)
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Discount period, DP1
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10
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days
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Under the proposed terms of sales:
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Discount percentage, CD2
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0.03
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(or, 3.0 percent)
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Discount period, DP2
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5
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days
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Estimated bad debts, BD2, as percent of sales
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0.015
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(or, 1.5 percent)
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a. Compute the NPV of the company's existing terms of sales based on its operating budget and other information provided, above. Show computations in good form and label properly all amounts presented.
b. Compute the required sales volume, Q2, under the proposed terms of sale necessary to achieve the NPV of the existing credit policy - i.e., the "break even" unit sales volume. Show computations in good form and label properly all amounts presented.
Topic 4
Demonstrate your ability to apply financial ratio analysis to common-sized financial statements. Analyze the common-sized balance sheet and income statement of FirstRate Company, included in the Topic 8 background paper, Financial Ratio Analysis. Identify the most significant:
- Trends in the 20X0 - 20X4 common-sized financial information, and
- Differences between the common-sized financial information of the company and its industry's norms
Your analysis should indicate the basis on which you identified trends or differences as significant, including the potential implications for FirstRate's business or financial condition.
Limit your response to a maximum of 200 words. Spell-check and-grammar-and-style-check your completed response using MS Word's tool for this purpose, being sure to correct any matters identified by these checking tools.
Topic 5
The CEO of North American Manufacturing Company has asked you to (a) complete the projected income statement and projected balance sheet for the coming fiscal year (FY) of the company using the information set forth below. She has also asked you to (b) determine the amount of any additional external financing the company will require during the coming fiscal year and (c) assess the reasonableness of the projections in relation to the company's estimated cost of equity capital, rE, and its sustainable sales growth rate.
1. Use the average gross margin during the preceding two-year period to project the amount of gross profit.
2. Use the average ratio of "all other S&A-to-sales revenue" during the preceding two-year period to project the amount of all other S&A expense.
3. Use the average amount of R&D expense during the two preceding FYs to project the amount of this expense.
4. The estimated combined effective income tax rate during the projected FY is 0.40 (40.0 percent).
5. Project the balances of cash and cash equivalents, total current assets, and total liabilities as "residual amounts" using the general methodology examined in Topic 9 of the course. Project total assets using the projected balance of total liabilities and shareholders' equity. Project the balance of total liabilities and stockholders' equity based on projected total stockholders' equity and a targeted total debt ratio (ratio of total liabilities-to-total stockholders' equity) of 0.70 (70 percent).
6. Project the balance of accounts receivable (AR) using a projected average AR collection period ratio of 45 days.
7. Project the balance of inventory using a projected average days to sell inventory ratio of 90 days.
8. Project the balance of other assets using the average balance of this item during the two preceding FYs.
9. Project the balance of accounts payable (AP) using projected "cash costs" and a projected average AP payment period of 45 days. "Cash costs" include projected COGS and operating expenses, excluding depreciation.
10. Project the balance of dividends payable as the dividends that the company expects to declare during the final week of the projected FY (based on net income for that year) and pay early in the next FY. The company's payout ratio (dividend policy) is 0.40 (40 percent).
11. The company plans no issuances (or repurchases) of common stock during the projected FY.
12. Project retained earnings (RE) using projected net income and projected dividends to be declared near the end of the projected FY.
13. The company's estimated cost of equity capital, rE, is 0.227 (22.7 percent), computed using CAPM as: rF + β x (rM - rF) = 0.04 + 2.2 x (0.125 - 0.04)
a. Prepare Projected income statement & Projected balance sheet
b. Determine the amount of any additional external financing the company will require during the coming FY. Show computations in good form and label properly all amounts presented.
c. Assess the reasonableness of the projected financial statements in relation to the company's estimated cost of equity capital, rE, and its sustainable sales growth rate.