Corporate Financial Management Discussion

Corporate Financial Management Discussion

QUESTION 1 (25 points): Utilizing the financial statements for Major Media Company

(included in your Midterm Exam Excel file), perform the following computations.

a. Compute the Company’s EBIT and EBITDA for each year presented.

b. Compute Gross margin, EBIT margin, and EBITDA margin for each year presented.

c. Analyze Revenue, EBIT, and EBITDA growth. Compute both year-over-year growth

and the compound annual growth rate (CAGR) for the period presented.

d. Compute the following ratios. Assume a 365 day year and use end-of-year asset and

liability balances.

a. Current ratio

b. EBIT Coverage ratio

c. Long Term Debt ratio

d. Asset Turnover ratio

e. Days Receivable Outstanding

e. Decompose the company’s Fiscal Year 2006 Return on Equity (RoE) using a Dupont

Analysis. Label each component.

f. Pick what you believe are two important elements of the company’s financial profile and

briefly (1-4 sentences) explain what they may mean for the company’s future

performance.

QUESTION 2 (25 points): D. Lisch Gluten, a cookie manufacturer, is stable, low-growth,

company with the following characteristics:

• RWG had sales of $3 million in the most recent year.

• Cost of goods sold was $1.75 million, of which $1 million was materials.

• RWG pays its suppliers 30 days after receiving the invoice and it pays its labor force

at the end of each month.

• The company sells to grocery stores and receives payment 60 days after it invoices its

customers.

• RWG typically keeps 15 days of sales in inventory.

• The company’s Selling, General, & Administrative expenses totaled $600,000 in the

past year.

• Sales and costs occurred at a constant rate throughout the year.

• Assume a 360 day year in your computations.

• The company’s tax rate is 40%. It made estimated tax payments of $65,000 in April,

July, September, and December.

a. Using the data above, compute the company’s year-end Accounts Payable, Accounts

Receivable, and Inventory balances. Please show your work for partial credit.

b. What is the length of the company’s operating cycle? Please show your work for partial

credit.

c. What is the length of the company’s cash cycle? Please show your work for partial

credit.

d. Prepare a cash budget for December using the direct method. Assume the company

began the month with $100,000 in cash. How much cash did it end the month with?

Ignore interest income and interest expense.

QUESTION 3 (30 Points): You work for a major robotics company and are evaluating the

launch of a new product, tentatively named STUDENTfriend. STUDENTfriend is a robot with

highly sensitive chemical receptors that allow it to sense the stress and anxiety levels in humans.

When stress is elevated, the robot is programmed to approach its human owner, pat it on the

back, and whisper encouraging words like, “Don’t worry” and “No one will care about your

grade on your finance midterm after you graduate.” The project specifics are as follows:

• The company has already spent $20 million developing the robot. An additional $15

million would be required to commercialize the current prototype, all of which will be

borrowed. Assume that the investment is made today.

• The company plans to use an unused building it owns to produce the product. The

market value of the building and land if sold today is $3 million. The building is fully

depreciated from a book value standpoint.

• Machinery to produce the robot will cost $10 million and will be depreciated over 5 years

using a straight line method.

• The project is expected to last 5 years, until advancing technology renders the robot

obsolete.

• Revenue is expected to be $15 million in year 1 and $20 million in year 2, before

declining by 10% in each of the three subsequent years.

• Production costs are anticipated to be 40% of revenue.

• Selling, general and administrative costs are estimated at $2 million in year 1, $3 million

in year 2, and $1 million thereafter.

• Working capital is anticipated to be 10% of sales, half of which will be returned at the

end of the project and half of which will be written off.

• Loving robots are made with toxic materials. Environmental cleanup, net of the sale

value of the land and building, is anticipated to cost $400,000 at the end of the project.

• The company’s marginal tax rate is 35%.

a. Given the proposed set of facts and the figures above, compute the project’s debt-

free (unlevered) cash flows.

b. The company’s after-tax cost of debt is 4% and its cost of equity is 15%. The

company’s current weighted average cost of capital is 11%. If the project is

accepted, the company’s weighted average cost of capital will be 10%. What is

the appropriate discount rate to use for evaluating the project?

c. Perform an NPV analysis utilizing the discount rate you have selected. Include all

relevant cash flows. Utilize the mid-year convention to discount all future cash

flows.

d. Compute the internal rate of return of the project.

e. Should the company accept undertake this project? Why or why not?

QUESTION 4 (20 Points): You are working with the CFO of your company on a report that will

be used to set financial policy for your company. As your company has several new board

members without finance experience, you have to start with basic concepts before you move into

analysis and recommendations.

a. In one or two sentences, explain what is meant by the term “optimal capital structure”?

b. What is meant by the term financial flexibility?

c. In one or two sentences, describe one possible advantage of financial flexibility.

d. In one or two sentences describe a possible disadvantage of financial flexibility.

e. You are analyzing another company (the “peer company”) in the same industry as yours.

Your company had EBIT margins ranging from 9-11% in the last five years. The peer

company had EBIT margins ranging from 5-15% over the same time period, and a debt-

to-enterprise value of 30%. Based solely on this information, would you recommend

your company have more, less, or the same amount of debt? Why (1-4 sentences)?

f. Your company is trying to decide between issuing $100 million in 5 year bonds or $100

million in 10 year bonds. In 1-4 sentences, describe the factors you would consider in

developing a maturity recommendation.

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