1. Daffodil Electronics has grown from a company with 10,000,000 turnover to one with a 201m turnover and 18m profit in the last twenty years. The existing owners have put all their financial resources into the firm to enable it to grow. The directors wish to take advantage of a fascinating market opportunity after Brexit but would need to find 50m of new equity capital as the balance sheet is already over-geared (i.e. has high debt). The options are discussed in a relatively uniform way, including flotation on the Main Market of the London Stock Exchange, flotation on the Alternative Investment Market (AIM), and private equity. 2. Ms Victoria is the Investment Manager and has requested some analysis concerning a proposed 5-years investment. The company plans to open a showroom in York and have narrowed their selection down to two locations: (1) City Centre and (2) Clifton Moor. You have to evaluate these options based on the following information. Daffodil willlease the showroom initially for 5 years, and the total initial cost of investment is estimated to be 10 million each. Option one: City Centre It is expected that the City Centre showroom will increase the overall sales revenue of the company by 10%per annum from 2020, and the variable cost will be forty-two percent of sales revenue. The fixed overhead cost will be 3,500,000, 2,000,000 and 1,500,000 in the first, second, and third years. The promotion cost will be 500,000 in the first two years and 200,000 for the next three years. All other expenses will be 10% of the total contribution margin. In the second year, the company will need a working capital investment of 2 million, and 60% of which will recover at the end of project life. The company follows a straight-line depreciation method and expects to sell the assets at 20 % of historical cost in year 5. Option two: Clifton Moor On the other hand, if the showroom is opened at Clifton Moor, then it will require fixed overhead cost for four years 2,500,000 in year one, 1,800,000 in year three, 2,100,000 in year four and 1,100,000 in year five. All other costs will increase and be at 10%per year of the contribution margin. The working capital investment will be 1,500,000 in year three, and 55% ofit will recover in the last year. The sales revenue will increase at 12% per annum, and variable cost will be 45% of sales. The company will follow a similar strategy for depreciation and promotional cost, just like the city centre. Financing the investment The company has several choices for financing this expansion - issuing new equity or bond or usingexisting retained earnings. The shares of Daffodilare traded in the Alternative Investment Markets (AIM) for 30, however, the face value is 20 and last year's dividend was 0.35. HSBC will charge a flotation cost of 10% to issue the new common stock in the market. There is a projection that the dividend will grow at 6% a year in the coming years. The firm can issue an additional long-term bond at an interest rate (before tax) of 10 % (i.e. Coupon rate). Currently, similar bonds are selling at 110, slightly over the face value (which is 100), with five years of maturity. The market risk premium is 5%, the 3- month UK gilt rate is 3.5% (risk- free rate), and the average Beta of the Electronic goods industry is 1.73. Thecompanyisalsoplanning to issue preferredstocks. The industry average preferreddividend and current market price are 10 and 96, respectively. The company wants to maintain a capital structure of approximately 45% debt, 5%preferred equity and 50% of ordinary equity. The current corporate tax rate is 35%. Required a) Determine the Weighted Average Cost of Capital (WACC) for target capital structure. b) Evaluate which showroomshouldbe selected (Hints: use NPVand IRR). Ms Victoria prefers to use CAPM (i.e., Capital Asset Pricing Model) over DDM (i.e., Dividend Discount Model). c) Advise accordinglywith appropriate assumptions andrationales for the future
