case study
Sheet1 DateYDLAll Ordinaries Index 12/31/144.625388.6 1/31/155.035551.6 2/28/154.935898.5 3/31/154.995861.9 4/30/154.935773.7 5/30/154.925774.9 6/30/154.865451.2 7/31/155.145681.7 8/29/154.575222.1 9/30/154.565058.6 10/31/154.395288.6 11/28/154.365218.2 12/31/154.565344.6 1/30/164.585056.6 2/27/164.274947.9 3/30/164.335151.8 4/29/164.495316 5/28/164.685447.8 6/29/164.665310.4 7/30/164.835644 8/30/164.45529.4 9/29/164.465525.2 10/29/164.295402.4 11/29/164.355502.4 12/30/164.395719.1 1/28/174.315675 2/28/174.155761 3/31/174.025903.8 4/29/173.765947.6 5/31/173.925761.3 6/30/173.835764 7/29/173.655773.9 8/31/173.275776.3 9/30/173.245744.9 10/31/173.285976.4 11/30/173.186023.5 12/30/173.376167.3 1/31/183.46146.5 2/28/183.116117.3 3/31/182.985868.9 4/28/183.026071.6 5/31/182.656123.5 6/30/182.486289.7 7/31/182.696366.2 8/31/182.946427.8 9/29/183.16325.5 10/31/182.995913.3 11/30/182.855749.3 12/29/182.775709.4 1/31/193.025937.3 2/28/193.046252.7 3/30/193.286261.7 4/30/193.336418.4 5/31/193.66491.8 6/29/193.86699.2 7/31/193.926896.7 8/31/193.676698.2 9/28/193.516800.6 10/31/193.496772.9 11/30/193.866948 12/31/193.546802.4 ( Page 1 of 10 ) Scenarios It is 31th December 2019. Your team of four people form a financial analysis team at Aussie Finance Consulting (AFC), a renowned financial institution. The executive management of AFC has assigned you a task to carry out a special project for its client Yarra Digital Limited (YDL), which requires preparing a business report. This report will be presented to AFC executive management and also to the senior management of YDL. YDL is a Victorian pay television company—operating in cable television, direct broadcast satellite television, and IPTV streaming services. It was formed in 1999 through a joint venture established between Yarra Broadcasting Corporation and Ultra Digital Network Limited, with Yarra Broadcasting Corporation being the 65% and Ultra Digital Network the 35% shareholders respectively. They provide a full range of television services to corporate and government customers including pay TV, data networks and mobility services through a range of carriers offering choice, control and cost reduction. YDL has been in the business for 20 years now. It is well established and profitably running business thus far. YDL has recently undertaken a market study which costed them $50,000. Findings of the study indicate that it is critical for YDL to upgrade their infrastructure to meet the demand of its customers. They plan to do the upgrade systematically in stages gradually over next few years. They also need to plan their finances to fund the upgrade plan. For the upgrade, they need some critical hardware components. The management has identified two options: (1) In-house production which requires the company to establish their own production facility; and (2) Outsourcing which implies external procurement of the necessary hardware. After a careful analysis, the management has worked out the following details for the two options: Option 1: In-house production The purchase and installation of the machinery shall cost $3,500,000 and has an economic life of twelve years. The machinery is expected to depreciate to zero on a straight-line basis over its economic life. However, the company expects to keep their in-house production for only seven years. At the end of Year 7, the machinery can be sold at an estimated market value of $1,700,000. Currently YDL has a warehouse which generates a rental income of $200,000 each year. To save on investment costs, the management intends to convert this warehouse into a factory for manufacturing various hardware components. The conversion cost is estimated to be $140,000 and treated as a capital expense. YDL also requires training its staff on the new machinery immediately after the installation. Training fees are expected to be $10,000 and fully tax-deductable. Annual maintenance cost of the machinery is $160,000. The collective cost of the hardware components to be manufactured is estimated to be $1,800,000 in Year – 1 with an expected increase of 4% per annum in the following years. YDL also needs to invest in necessary development software and maintain the licenses. The negotiated licensing fee for the software is estimated to be $57,000 per year. Finally, the management estimates that they shall need additional net working capital of $30,000 at the beginning of the production with an expected increase of 3% per annum in the following years. Option 2: Outsourcing Alternatively, YDL can contract with a firm named Innovative Equipment Limited (IEL) which is specialised in manufacturing the required hardware. Based on the types and expected number of units YDL would need, IEL management has quoted a total cost of $3,100,000 in Year 1 which will continue to grow at 6% per annum to keep up with the rising cost and forecasted growth in the number of the required units. IEL, however, has offered this rate on a condition of a five-year contract. Also, IEL requires that YDL pays 50% of the expected cost for a year in advance at the beginning of that year. From the accounting perspective, equipment that are procured from IEL may be classified as cost of goods sold in the books of YDL. Hence, they will be treated as operating expense for the business. Furthermore, as in Option 1 YDL still needs the warehouse to store the hardware. You are required to analyse the two given options and make recommendations to YDL about the option they should choose. For the purpose of the analysis, you have already assembled the following information: Balance Sheet of YDL as of 31 December 2019 Assets Cash at bank $700,000 Accounts receivable $550,000 Inventory $1,700,000 Marketable securities $6,670,000 Plant, machinery and equipment $150,500,000 Intangible assets $40,000,000 Land and building $30,000,000 Total $230,120,000 Liabilities Accounts payable $300,000 Bank overdraft $670,000 Commercial bills (due 30th Jun 2020) $3,000,000 3.75% Coupon bonds (due Dec 2029 issued @$100 each) $150,000,000 Shareholders' Fund Common stock 33,500,000 @ $2.209 each $74,000,000 Retain earnings $2,150,000 Liabilities + Shareholders' Fund $230,120,000 End-of-month stock prices for the market (All Ordinaries Index) and YDL adjusted for all corporate actions such as dividends and stock splits over the previous five years are provided in the file: BAFI1059_S1_2020_Project_Data.xlsx Additional Information: · The applicable interest rate on bank overdraft is 5.5% per annum and has monthly compounding. · The commercial bills are currently yielding 4.5% per annum with quarterly compounding. They will mature on 30th June 2020 however, will be replaced by newer issues on that date. · The bonds are currently priced at $102 each and pay coupons semi-annually on 30th June, and 31st December. · The coupon payment due to be paid on 31th December 2019 has been paid. · The applicable company tax rate is 30% and the proportion of tax collected from the company and is claimed by shareholders is 0.50. · The current yield on Australian Government 10-year bonds is 1.40% per annum. · The expected market return including franking premium is 9.25% per annum. Requirements You are required to advise the company on the following: a) Capital Budgeting Decision(30 marks) (i) Which of the two options should YDL pursue? Steps in part (a): The first part of the analysis requires you to work out the Weighted Average Cost of Capital (WACC) for YDL with the help of the given information and given data. (15 marks) Secondly, evaluate the two options using NPV analysis and clearly identify which of the two alternatives is better for YDL. (15 marks) b) Capital Structuring Decision(15 marks) In the next phase, YDL aims at expanding business beyond Victoria and cover all the major cities in Australia. YDL needs to raise more capital for the purpose. However, the executives worry about the high level of debt in the current capital structure and are debating if they should raise sufficient money through common stock only. They intend to use new capital for both (a) further expansion and (b) repaying debt. Doing so will eventually convert the company into an all-equity company. (i) Calculate the required rate of return on capital if YDL were to become an all- equity firm. (7.5 marks) (ii) In the light of Modigliani & Miller propositions in the perfect world but with corporate taxes, discuss your findings in both the possible scenarios about: · WACC / Cost of capital, and · Cost of equity. Essentially you need to report (no more than 250 words) if your workings validate the arguments forwarded in the Modigliani & Miller theory. (5 marks) (iii) Give your opinion if YDL should convert into an all-equity firm and explain why? (no more than 250 words) (5 marks) c) Dividend Policy Decision(15 marks) Another aspect that YDL executives are perplexed about is the dividend policy they should adopt. (i) Give your advice with reasoning to the YDL executives if they should pursue dividend distribution or retention as their dividend policy. (no more than 250 words) (15 marks) d) Evaluating Leasing Possibility(15 marks) Instead of purchasing the machinery, your team, being experienced consultants, wishes to propose to YDL that they have another option which is leasing it. Coincidently, your other client, New Leasing Limited (NLL), may be a suitable lessor. On discussions, the executives at NLL have asked you to prepare a lease quotation that could be forwarded to YDL for consideration. For the purpose, NLL has provided the following information: · NLL can get a 5% discount on the purchase and installation price of the machinery. · They expect the life of the machinery to be twelve years with no salvage value after that. YDL may use this machinery for seven years, and NLL is confident that it can be leased to others after that. · NLL uses the straight-line method for calculating depreciation. · As the owner of the machinery, NLL is responsible for its annual maintenance cost. · NLL’s applicable tax rate is 30%. (i) If the NLL’s after-tax required rate of return is 12% per annum, what will be the minimum annual lease payment that NLL would charge? Consider that NLL requires lease payments to be made annually in advance. (8 marks) (ii) Calculate the maximum annual lease payment that would make leasing a viable option for YDL? (7 marks) e) Business Report Overall Quality(10 marks) The assignment is to be presented as a business report to both AFC and YDL executive management. This report needs: · Page numbering · Informative heading and sub-headings · Numbered sections · Executive summary · Table of contents · Reference list Your report is to be submitted as a PDF version of your work. The report must use a font/fonts suitable for business communication. The reference style to be used is Harvard style referencing (author-date). Your main report will have word limit of 3,000 words approximately excluding appendix and will be professionally presented. A concise, relevant and visually appealing paper is essential for business communication. General Instructions Essential Contents: Your report needs to set out the following at it least: · An executive summary · A table showing the calculation of