This is contiuation of task1, 2, 3, 4, 5 and 6. Now we are at Task 7, 8 and 9 that needs to be done. Task 1 - 6 completed by you. Need to complete Task 7 - 9. Please worksheet for EACH task ( 7, 8 and 9). and written report for each task as well. Thank you.
Task 7 In your discussions with the CFO, you have talked about the impact of a dividend on your firm’s market price and financial statements. He has asked that you and your team evaluate the impact of issuing a dividend. Your starting point for analyzing dividends is the Modigliani-Miller (MM) Theorem. If MM assumptions are true, what would be your recommendation for dividends? Now assume that the only MM assumption that is not true is that payments to debt holders may be deducted as an expense for tax purposes, what would be your recommendation for dividends? Now assume that the rate of long-term capital gains is lower than the marginal income tax rate for your equity holders, what would be your recommendation for the choice between dividends and share repurchase? Moving on from MM, now use the income statement and balance sheet provided to make a recommendation for the amount of dividend (if any). How are retained earnings impacted and what does this mean for the organization? Concept Check: Dividends are distributions of profits to your investors who placed their capital at risk for you. Theoretically, every company should eventually provide a dividend distribution to their investors. Helpful Hint: Dividends are voted on every quarter by the Board of Directors for a company; the amount of the dividend or if any is paid can be decided at that time. Task 8 Share repurchase proposal: Currently, the firm has available capital (cash and net income) of approximately $75,000,000. There is a large block of stock available at $325 a share. For the sake of this exercise let us disregard tax implications and effects. If the firm decides to spend this amount of excess cash on a share repurchase program, If the firm decides to spend this amount of excess cash on a share repurchase program, how many shares will be repurchased? how many shares of stock will be outstanding after the stock repurchase is completed? What are the benefits of repurchasing shares? How will this affect the capital structure of the company? How can this be interpreted in the marketplace? Suppose the market price of the shares is $35.75 a share. Why do you think the seller of the large block would agree to see at $35 a share? Suppose the assumptions of MM are true, then what would happen to the market price of shares once the purchase of the large block at $35 a share is completed? Would it rise above $35.75, remain unchanged or fall? Would a dividend be better? Please discuss the pros and cons of dividends and share buybacks. Make a recommendation to management. Concept Check: There are tax ramifications that tend to get very complex; for the sake of this exercise let us disregard tax implications and effects. Task 9 Evaluation of potential acquisition: BBE is considering the acquisition of Martin & Sons, which has $5.3 million in net working capital. They also have total assets with a book value of $58.6 million and a market value of $63.4 million. They currently carry no debt on their balance sheet, sales are expected to be $52 million next year, and their tax rate is like BBE at 36%. Through a mixture of synergistic savings and increased market share, this acquisition should add $2.3 million in net profit per year for the next 10 years. BBE is considering buying the company for $60 million in cash. The acquisition will be recorded using the purchase accounting method. How do you recommend the firm finance this transaction? Is there a danger that BBE could damage their finances to the point that bankruptcy is a potential? Concept Check: 5-factor model of the Altman Z-score (a for private manufacturing firms): Z-score = 0.717T 1 + 0.847T 2 + 3.107T 3 + 0.42T 4 + 0.998T 5 where, T 1 = Working Capital / Total Assets T 2 = Retained Earnings / Total Assets T 3 = Earnings BeforeInterest and Taxes / Total Assets T 4 = Equity / Total Liabilities T5 = Sales / Total Assets Zones of Discrimination: • 23 or less – “Distress” Zone • from 1.23 to 2.9 – “Grey” Zone • 9 or more – “Safe” Zone Interpretation of Altman Z-Score The Z-Scores help predicts corporate defaults as well as an easy-to-calculate measure of control for the financial distress status of companies in academic studies. A Z-Score above 2.6 (2.9) indicates a company to be healthy. Besides, such a company is also not likely to enter bankruptcy. However, Z-Scores ranging from 1.1-2.6 (1.23-2.9) are taken to lie in the grey area. Sheet1 Data from Financial Statements Particulars20202021 Current Assets128,950,000144,975,000 Inventories112,000,000127,000,000 Current Liabilities132,524,000144,002,000 Long-term debt115,000,000130,000,000 Total Owner's equity169,426,000170,473,000 Net IncomeN/A9,045,000 Financial Ratios 20202021 1. Working Capital Ratio0.971.01 2. Quick Ratio0.130.12 5. Debt-Equity Ratio0.680.76 6. Return on EquityN/A5.31% Capital Asset Pricing Model (CAPM) Expected market return6.00% Risk-free rate2.00% BEB Beta1.20 Rate of Return6.80% FIN 620 Lon-Term Financial Management Task 2 Capital Structure and Weighted Average Cost of Capital: In this task, we are examining the current capital structure of BEB and determine the WACC of the company. Assume that BEB’s tax rate is 36%. To compute the WACC you must first find the after-tax cost of debt, the cost of equity, and the proportions of debt and equity in the firm. You can assume that the cost of debt before tax is 7.5% for the firm. Please clearly show how you derive each of these values: The after-tax cost of debt = Cost of equity = (from your previous task) Proportions of debt and equity in the firm (from the balance sheet) = How do we compute the WACC in this circumstance? Why do we need to be concerned with the WACC? Any insights into the capital structure of BEB ? Concept Check: Capital structure for a public company consists of both debt and equity. We must take into account the ability to write off interest payments in the calculation of our cost of debt which results in an after-tax cost of debt being used in our WACC calculation. The weighted average cost of capital is the weighted average of the cost of equity and the after-tax cost of debt. Another way of looking at this is by computing the effect of the capital structure on expected returns by investors. WACC= (S/(B+S) x Rs) + (B/(B+S) x RB x (1 – tc)) Where S = value of equity B = value of debt Rs = cost of equity After tax cost of debt: RB x (1 – tc ) Helpful Hint: One thing to bring up here is WACC is needed to determine risk on several levels. To determine risk we need to remember the following items: 1. Risk is a deviation from expectations. 2. We need to set expectations for our investments based on risk and return. Higher risk = higher return. 3. Capital is obtained from the marketplace in two forms; equity and debt. This is the capital structure of a corporation and impacts the profits of a company depending on how this is managed. 4. We use our cost of capital to discount any cash flows from new investments (NPV and IRR analysis). 5. If the cost of capital rises then our risk rises and the projects we undertake to increase sales and return to our investors are reduced. 6. If debt rises then our obligation to make payments on interest increases and profits can decrease if sales do not increase rapidly enough. 7. If risk increases our beta will increase to show the increase in risk. This will increase our required rate of return to stockholders (CAPM) and thus increase our required rate of return we must use in discounting future cash flows. Task 3 To illustrate and further support our strategic financial planning systems we need to show the CFO and management team an example of the application of the previously constructed WACC. The CFO thinks that showing management how we can validate and choose projects based on expected returns developed from the WACC will help reduce the risk of our investor’s capital thus lowering the required rate of return we would have to provide to those investors. If we lower our expected return we can then do more projects and grow at a faster rate. He has asked your team to evaluate the following project: Capital investment: BEB is planning the construction of a new loading ramp for its single mill. The initial cost of the investment is $600,000, followed by an investment of $200,000 10 years later and another investment of $200,000 20 years later and finally an investment of $1,000,000 for environmental cleanup at the end of the project 30 years from now. Efficiencies from the new ramp are expected to reduce costs by $50,000 per year (at the end of every year) for the life of the plant, which is currently estimated at 30 years (savings of $50,000 a year from 30 years). These savings can be assumed to be reinvested at a rate of 9% pa. What is the NPV of the project if BEB has a required rate of return of 7%? What is the MIRR of the project if the investing return rates (with the loading ramp used as collateral) for a period of 10 years is 6% pa and the term structure of investing return rates for Y years (Y > 15) is 6% + 0.0183*(1 - (1/(Y-9)) pa? You should use these investing return rates to discount back (to the present) the future investments that the loading ramp needs. Concept Check: We need to adjust cash flows to account for things like inflation, our cost of capital, and opportunity costs. Simply looking at cash flow not adjusted for some of these costs will lead to taking on projects which are not adding to the value of the organization. Helpful Hint: The first step in conducting an NPV analysis is to include all the relevant cash flows. This includes savings from taxes and any expenses directly related to the venture. We reject any project with a negative NPV. Task 2 Given: Tax Rate36% Cost of debt before tax 7.50% Long-Term Debt130,000,000.00 Current Portion of LT Debt5,350,000.00 Total Debt135,350,000.00 Cost of Equity6.80% Total Owner's equity$170,473,000.00 Calculations: After-tax cost of debt Cost of debt before tax *(1-Tax Rate) After-tax cost of debt 4.800% Proportions of debt and equity in the firm ParticularAmountWeight Total Debt$135,350,000.0044.26% Total Owner's equity$170,473,000.0055.74% Total$305,823,000.00100.00% We compute the WACC in this circumstance by multiplying the weight of each source of Capital with its Cost. Because the WACC is used to assess the present value of future cash flows, it is extremely essential. If the WACC is low (as it is here), it is a favourable sign since it indicates that future cash