Business overview Game of Function Inc. (GFI thereafter) was a large producer of laboratory appliances used in hospitals, research centres and universities. For the period 2013-2016 the industry posted modest annual unit sales growth of 2.9% despite positive market conditions after a full recovery from the Global Financial Crisis. Competition from inexpensive imports and aggressive pricing by peers has reduced the annual growth rate of GFI to 2.5% over the period. Ricky Fauci became the new CEO in 2017. Under his leadership, GFI managed to secure a large long- term contract from a state-owned research lab in China to supply lab equipment. Unknown sources reveal that such demand is due to a new joint project on COVID-related research funded by the United States government authorities. Riding on this success, the company completed an IPO (Initial Public Offering) in 2018. This provided a measure of liquidity for founders' descendants who, collectively, owned 62% of the outstanding shares following the IPO. With the vision to further expand the company, GFI rented a site in Southern Queensland as a second factory and started supplying products to clients in other South East countries from the beginning of 2019. In addition, GFI had also undertaken a strategy focused on rounding out and complementing its product offerings by acquiring small independent manufacturers and/or laboratory related appliances and accessories of large diversified manufacturers. GFI's recent performance The COVID-19 hit the market in early 2020, imposing irrevocable impact on all businesses. GFI's share price took a plunge when its partner in China was under scrutiny of foreign media and later investigated by health experts appointed by the World Health Organization (WHO). It then went back up by a considerable amount when the investigation did not lead to substantial evidence. As a result, the total return earned by GFI shareholders (including dividends and stock price appreciation) last year was approximately 9.5%. This was higher than the ASX S&P200, which returned a minuscule 1% over the same period. However, it was still below the 11% earned by shareholders of GFI's peer group during the same period, possibly due to GFI's close association with the COVID lab that had been widely covered by media. During the year ended December 31, 2020, GFI earned net income of $8.25 billion on revenue of $108.13 billion. Exhibits 1 and 2 present the company's recent financial statements. The company's 2020 EBIT margin of nearly 7.6% was average within the peer group. GFI's financial position was conservative and very much in keeping with GFI's long-standing practice and, with its management style. In recent years the company's largest uses of cash have been common dividends and cash consideration paid in various acquisitions. Dividends per share had risen only modestly during 2018-2019. However, as the company issued new shares in connection with some of its acquisitions, the number of shares outstanding increased to approximately 1.27 billion by the end of 2020. + GFI's financial position was conservative and very much in keeping with GFI's long-standing practice and, with its management style. In recent years the company's largest uses of cash have been common dividends and cash consideration paid in various acquisitions. Dividends per share had risen only modestly during 2018-2019. However, as the company issued new shares in connection with some of its acquisitions, the number of shares outstanding increased to approximately 1.27 billion by the end of 2020. Average Number of Shares Outstanding (000s) 1,267,881 Average Cost of Debt Current Stock Price 5.0% $114.33 On a bright Friday afternoon, Ricky Fouci sat in his office reflecting on a meeting he had with an investment banker earlier in the week. The banker, whom Ricky Fouci had known for years, asked for the meeting after a group of private equity investors made discreet inquiries about a possible acquisition of GFI. Although GFI was a public company, a majority of its shares were controlled by family members descended from the firm's founders together with various family trusts. Ricky Fouci knew the family had no current interest in selling - on the contrary, GFI was interested in acquiring other companies in the same industry - so this overture, like a few others before it, would be politely rebuffed. Nevertheless, Ricky Fouci was struck by the banker's assertion that a private equity buyer could "unlock" value inherent in GFI's strong operations and balance sheet. Using cash on GFI's balance sheet and new borrowings, a private equity firm could purchase all of GFI's outstanding shares at a price higher than its current stock price of $114.33 per share. It would then repay the debt over time using the company's future earnings. The banker pointed out that GFI itself could do the same thing - borrow money, say, $10 billion dollars, to buy back its own shares. In the days since the meeting, Ricky Fouci's thoughts kept returning to a share repurchase. Working as the new analyst for the company, your boss who work directly under Ricky Fouci asked you to prepare a report to explain the pros and cons of this deal. Here is a draft of your report. Question: 1. Assuming perfect capital market. For Game of Function Inc. (GFI), compute the market debt to equity (D/E) ratio, the cost of equity (rE) and the weighted average cost of capital (WACC) for GFI. It is assumed the cost of unlevered equity (ru) is 10%, use the (Q1) table below and showing working on another sheet. 2. Using Corporate Tax Rate of 36.5%. For Game of Function Inc. (GFI), compute the market debt to equity (D/E) ratio, the cost of equity (rE) and the weighted average cost of capital (WACC) for GFI. It is assumed the cost of unlevered equity (ru) is 10%, use the (Q2) table below and showing working on another sheet. (Hints: (1) the market value of debt is the sum of Long-Term Debt and Short-Term Debt/Current Portion of Long-Term Debt subtracting Cash and Cash Equivalents from the balance sheet. (2) Use market value of equity in calculating WACC.) Question Information: Value of debt 000s Mkt value of Equity 000s Market value of assets Market D/E ratio Unlevered cost of equity (ru) rD rE WACC Q1 Perfect Capital Mkt Q2 @36.5% tax rate Period Ending: Current Assets Cash and Cash Equivalents Short Term Investments Balance Sheet (000s) 31/12/2020 1,723,000 0 1,484,000 Income Statement (000s) Net Receivables Inventory Other Current Assets Period Ending: Total Revenue Cost of Revenue Gross Profit 31/12/2020 Total Current Assets 11,079,000 1,016,000 15,302,000 108,128,800 70,488,600 Long Term Assets 37,640,200 Fixed Assets Goodwill Operating Expenses Intangible Assets Sales, General and Admin. 21,884,200 Other Assets Other Operating Items 2,146,300 Total Assets 22,720,000 1,353,000 0 571,000 39,946,000 Operating Income 13,609,700 Additional income/expense items 438,100 Liabilities & stockholders' Equity: EBIT 14,047,800 Accounts Payable 9,473,000 Interest Expense 1,079,000 Short Term Debt/Current Portion of Long-Term Debt 328,000 Earnings Before Tax 12,968,800 Other Current Liabilities 1,468,000 Income Tax 4,720,300 Total Current Liabilities 11,269,000 Net Income-Cont. Operations 8,248,500 Long Term Debt 16,869,000 Other Liabilities Deferred Liability Charges 1,844,000 642,000 30,624,000 Total Liabilities Share Holders Equity Common Stocks Capital Surplus Retained Earnings Treasury Stock Other Equity Total Equity 88,000 8,885,000 26,995,000 -26194000 -452000 9,322,000