Lion’s Den is an investment group who is reviewing investment opportunities for their client, ACME Industries, a diversified company involved in creating and manufacturing personal electronics and consumer goods. Your team is tasked with developing and presenting an investment idea to the Lion’s Den which will help strengthen ACME Industries’ business. The Lion’s will have multiple competing opportunities and they will advise Acme Industries which investment idea will have the best opportunity to improve their cash flows, return, growth and profits while minimizing risk.
Financial Management II 6203 Group Assignment Winter 2021 1 Weight: 15% of Final grade (10% - Content 5%- Presentation) Due Dates: Submission of Report: March 23rd 11:59pm Power Point Presentation: March 23rd 8:00am Group Presentations: March 23rd 8:00am (In-Class) Case Study Lion’s Den is an investment group who is reviewing investment opportunities for their client, ACME Industries, a diversified company involved in creating and manufacturing personal electronics and consumer goods. Your team is tasked with developing and presenting an investment idea to the Lion’s Den which will help strengthen ACME Industries’ business. The Lion’s will have multiple competing opportunities and they will advise Acme Industries which investment idea will have the best opportunity to improve their cash flows, return, growth and profits while minimizing risk. Background ACME Industries currently has annual sales of $40 million a year but, sales have been flat the last 3 years. They need to diversify their investments or reduce operating costs. They have come to the Lion’s Den, to help them assess potential investment ideas ( ie expansion of current production into a new market, new product line or other investment idea to expand their business). ACME Industries is a listed company on the stock exchange and has two million shares outstanding and $100 million in long term debt (ACME 9%, 2035, Rated A). However, given cash flow has been dropping the last few years, they will need to raise new capital to fund any new investment idea. ACME will be open to new investments as well as raising capital either through common share issuance, or debt but need to minimize the impact on earnings per share for both options. Your role will be to develop and propose a new investment idea to Lion’s Den. It could be to retool or replace existing production equipment, move to cheaper facilities, or add additional product lines to diversify their lineup all of which require investment in new capital assets. Your group will develop the capital budgeting analysis of your investment solution as well as analysis on the type of financing they should use to fund the investment and expected costs. You will need to estimate and justify the cash flows and expenses over 5 years. A balance sheet and income statement for ACME has been provided along with some of the data needed for your analysis. Your group will need to submit ONE detailed summary document outlining the benefits, risks, and capital budget analysis for your investment including all analysis outlined below. The summary should include all steps and calculations for each item as well as justifications for assumptions and estimated numbers. Choose one member of the team to submit electronically by the deadline March 23rd 11:59pm. Financial Management II 6203 Group Assignment Winter 2021 2 In addition, the group will present a 10minute power point pitch of your investment solution to Lion’s Den explaining the benefits, risks as well as various costs, cash flows, decision tree analysis, net asset profile and funding recommendations for the investment idea. You need to convince the Lion’s Den your idea is best! Be creative with your presentation and storyline! The soft copy should be submitted by March 23rd at 8am. Summary should include the following analysis: 1. Outline and describe the five Capital budgeting decision process steps you would take to access the investment opportunity. (Reference Page 394). Provide a background and summary of your idea including estimates for revenue, net operating cash flows , sales, earnings, investment costs, expenses over 5 year time horizon. Justify your assumptions based on similar industry trends and summarize in a table. 2. ACME currently has Common Equity and Long term bonds outstanding and will not consider preferred shares. Calculate price of the current bond using the required rate of return. Calculate cost of debt, and new external equity using the dividend growth model and flotation costs indicated in the summary table. (Chapter 11). 3. Calculate the market value of current stock and bonds, and use to determine current capital structure weighting. Use weightings and cost of debt & equity determined in Step 2 to calculate the WACC. (Chapter 11) 4. Calculate required return on common stock using CAPM. If you substitute this rate for the cost of equity how does it change the WACC? Determine which WACC will be used to discount your future cash flows and why? (Chapter 11 ) 5. The cost of equity increases if new equity is issued, what amount of investments can be covered by retained earnings of $2 million? If the current cost of debt applies to an additional $1,000,000 of debt, what dollar amount of investments can you fund using $1,000,000 in additional debt? (Hint: Marginal Cost of Capital). If you need more capital than either of these results can support, what would be the increased cost to fund if additional funding increased costs by 10%. I.e. Cost of debt increased by 10% or cost of equity increased by 10%. How would the increased costs affect the WACC calculated in previous calculations? Financial Management II 6203 Group Assignment Winter 2021 3 6. What type of capital would you use to pay for the investment, i.e. stock issue or debt? Explain why and discuss the associated costs for each method and benefits of each potential option. Estimate the price you would issue equity and number of shares to cover investment (current shares are trading at $40). Using equity, include the spread and the amount ACME would receive after paying underwriting fees on common equity. Calculate the dilution from the stock issue if current EPS= $3.00. (You can estimate what future earnings your investment will generate for dilution). (Chapter 15) For debt issue, what coupon would need to be offered on debt option (compare to YTM of bonds with similar term/rating)? Determine the interest payments required each year for the dollar notional you would need to raise. Indicate maturity and calculate the Present Value (PV) of the bond payments using new after-tax cost of debt as discount rate and base upon the yield required for new bonds. (Chapter 9, 16) 7. Create Net Operating Cash Flow summary table (pg 340) using you estimated revenue, adjusted for amortization (CCA) and taxes. Note: First year CCA is only 50% when determining cash flows. (Pg 417). Evaluate your Investment proposal using NPV, IRR, PI and Payback methods for 5 year period. (Identify Discount rate used based on previous calculations). Explain outcomes based on results. (Chapter 12) 8. Determine the PV of the CCA tax shield using 20% CCA, calculated discount rate. (Assume ITC is not applicable, no salvage value, and new investment is the only asset in the pool with no sales expected). (Chapter 12 Page 420-421). 9. Summarize resultant Net Present value (NPV) of cash flows based on 5 year time horizon in table. (See table 12-16 as guideline, use working capital=$10,000). 10. Estimate and create a probability table or tree for your cash flows. Determine risk: Expected return, standard deviation, coefficient of variation and briefly explain the results. (Chapter 13 Page 451) 11. Analyze refunding the current bonds for new lower cost bonds assuming 5% coupon is required with same maturity (2035) and rating (A) as existing bond. Use short term rate for reinvestment of funds during overlap. (Chapter 16- Pages 547-549) Financial Management II 6203 Group Assignment Winter 2021 4 12. Loan vs. lease: If you were to lease equipment for your new investment, indicate whether you would lease or borrow to purchase with a detailed account of costs and NPV of each. Use estimated cost of lease payments and loan amounts based on investment costs and assume payments are based on a 5 year time horizon. (Chapter 16 Lease vs. Purchase Page 559-561). *Please note: You must cite ALL content that is not your own creation. It is expected that the vast majority of this report will be in your own words. If material is not cited and is not original, it is considered plagiarism and a mark of zero will be issued along with an Academic Alert for plagiarism. PLAGARISM is also defined as submitting the same work for two courses or Professors without the knowledge and approval of the Professor. Please consult your professor if you have any questions or concerns about this. Report Notes: • The Report should include all the above criteria and be summarized in an organized and easy to read report with summary analysis. Graphic tables and charts are recommended! • You must submit both your Presentation file and your final report file to the DC Connect Assignment Drop Boxes on or before the due date and time. Assignments are to be submitted on the due date at the specified time. *** • DUE DATE Presentation (5%): Mar 23rd at 8am PLEASE REVIEW THE RUBRIC IN FULL BEFORE YOUR PRESENTATION DATE! • DUE DATE Final Report (10%): Mar 23rd at 11:59pm PLEASE REVIEW THE RUBRIC IN FULL BEFORE SUBMITTING YOUR REPORT! • Total Value = 15% of your final mark *** Assignments are to be submitted on the due date at the specified time. Late assignments will be penalized 20% per 24hour period starting immediately after the due date and time. After 24 hours another 20% will be deducted up to 48 hours, after 48 hours up to 72 hours another 20% will be deducted. If after 72 hours an assignment has still not been submitted, a mark of 0 will be awarded. There are no “make ups” for missed Presentation– if groups do not present on the presentation date a mark of zero will be assigned. There will be no exceptions of any kind to this policy. Financial Management II 6203 Group Assignment Winter 2021 5 Financial Statements ACME Industries Income Statement For year 2020 Sales $ 40,000,000 Cost of goods Sold 20,000,000 Gross profit 20,000,000 Selling and admin expenses 3,000,000 Operating profit (EBIT) 17,000,000 Interest Expense 9,000,000 Net Income before taxes 8,000,000 Taxes (25%) 2,000,000 Net Income (Earnings) $6,000,000 ACME Industries Balance Sheet As of December 31, 2020 Assets Cash $3,000,000 Marketable securities 3,000,000 Accounts receivable 7,500,000 Inventory 10,000,000 Total current assets 23,500,000 Net