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BFA728 assignment RWC2016 UNIVERSITY OF TASMANIA Tasmanian School of Business and Economics Finance for Managers BFA728 Semester 2 2016 ASSIGNMENT: Due Date: No later than 2 pm on 19th September 2016 Assessment: 20% This assignment is designed to introduce you to: Case studies, Construct a cash budget, Risk/return analysis as a basis for making investment decisions, Explain the risk and techniques associated with evaluating projects, Financial planning and controlling operations, and Additional research skills outside course materials/delivery. ___________________ Required: In your answer you should consider the following: 1. Ensure that you answer all the requirements of each question. 2. On campus students only: please note new submission rules and submit on MyLO drop box plus a hardcopy to be submitted to the drop box at the TSBE building L3. 3. This assignment consists of two (2) questions of unequal weight. 1 BFA728 assignment RWC2016 Case study one You have been hired as a financial consultant to Tamar Circuitry Ltd (TCL), a large publicly traded firm that is the market share leader in radar detection systems (RDS). The company is looking at setting up a manufacturing plant overseas to produce a new line of RDS's. This will be a five year project. The company bought some land three years ago for $4 million in anticipation of using it as a toxic dump site for waste chemicals, but it built a piping system to safely discard the chemicals instead. The land was appraised last week for $5.1 million. In five years, the after tax value of the land will be $6 million, but the company expects to keep the land for a future project. The company wants to build its new manufacturing plant on this land; the plant and equipment will cost $35 million to build. The following market data on TCL's securities are current: Debt: 240,000 7.5 percent coupon bonds outstanding, 20 years to maturity, currently trading at $940; the bonds have a $1,000 par value each and make semi-annual payments. Ordinary Share: 9,000,000 shares outstanding, selling for $71 per share; the beta is 1.2. Preference Share: 400,000 shares of 5.5 percent preferred stock outstanding, with a face value of $100, selling for $81 per share. Market: 8 percent market risk premium; 5 percent risk - free rate. TCL uses Shylock Ltd as its lead underwriter. Shylock charges spreads/flotation costs of 8 percent on new share issues, 6 percent on new preference share issues and 4 percent on debt issues. Shylock has included all direct and indirect issuance costs (along with its profits) in setting these spreads/flotation costs. TCL's tax rate is 35 percent. The project requires $1,300,000 in initial net working capital investment to reach operational stage. Assume Shylock raises all additional financing needed for new projects externally. 2 BFA728 assignment RWC2016 Required a. Calculate the project's initial investment at time 0, taking into account all side effects including weighted flotation costs. [1.5 marks] b. The new RDS project is somewhat riskier than a typical project for TCL, primarily because the plant is located overseas. Management has told you to use an adjustment factor of + 2 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating TCL's project. [2 marks] c. The manufacturing plant has an eight year tax life, and TCL uses straight line depreciation. At the end of the project (that is, the end of year 5), the plant and equipment can be scrapped for $6 million dollars. What is the after tax salvage value of this plant and equipment? [1 mark] d. The company will incur $7,000,000 in annual fixed costs. The plan is to manufacture 18,000 RDS's per year and sell them at $10,900 per machine; the variable production costs are $9,400 per RDS. What is the annual operating cash flow (OCF) from this project? [1 mark] e. TCL's financial controller is primarily interested in the impact of TCL's investments on the bottom line of reported accounting statements. What will you tell her is the accounting break even quantity of RDS's sold for this project? [1 mark] f. Finally, TCL's chief executive officer (CEO) wants you to prepare a draft report only showing what the RDS project's internal rate of return (IRR) and net present value (NPV). [3 marks] g. What will you report to the CEO? Include in your response to him the reasons why the NPV and IRR methods may give different answers in terms of accepting or rejecting projects. Explain the reasons for the conflict, and discuss how the conflict can be resolved. (250 words) [1.5 marks] 3 BFA728 assignment RWC2016 Case study two Seven years ago, after 15 years in public accounting, Albert Hooker, FCPA, resigned his positions as manager of systems for Cooke, Bray and Jackson Public Accountants and started Montage Software Limited. In the two years preceding his departure from Cooke Bray and Jackson, Albert had spent nights and weekends developing a sophisticated cost accounting software program that became Montage's initial product offering. As the firm grew, Albert planned to develop and expand the software product offerings - all of which would be related to streamlining the accounting process of medium - to large sized manufacturers. Although Montage experienced losses during its first two years of operation - 2010 and 2011 - its profit has increased steadily from 2011 to the present (2016). The firms profit history, including dividend payments and contributions to retained earnings, is summarised in Table 1. Albert started the firm with a $100,000 investment - his savings of $50,000 as equity and a $50,000 long-term loan from the bank. He had hoped to maintain his initial 100% ownership in the corporation, but after experiencing a $50,000 loss during the first year of operation (2010), he sold 60% of the shares to a group of investors in order to obtain needed funds. Since then, no other share transactions have taken place. Although he owns 40% of the firm, Albert actively manages all aspects of its activities; the other shareholders are not active in the management of the firm. The shares closed at $4.50 in 2015 and at $5.28 in 2016. Albert has just prepared the firm's 2016 income statement, balance sheet and statement of retained earnings, shown in Tables 2, 3 and 4, along with the 2015 balance sheet. In addition, he compiled the 2016 ratio values and industry average values, which are applicable to both 2013 and 2016. These are summarised in Table 5. Albert is quite pleased to have achieved record earnings of $48,000 in 2016, but he is concerned about the firm's cash flows. Specifically, he is finding it more and more difficult to pay the firm's bills in a timely manner. To gain insight into these cash flow problems, he is planning to prepare the firm's 2016 operating cash flow and free cash flow. Albert is further frustrated by the firm's inability to afford to hire a software developer to complete development of a cost estimation package that is believed to have 'blockbuster' sales potential. Albert began development of this package two years ago, but the firms 4 BFA728 assignment RWC2016 growing complexity has forced him to devote more of his time to administrative duties, thereby halting the development of this product. Albert's reluctance to fill this position stems from his concern that the added $80,000 per year in salary and benefits for the position would certainly lower the firms earning per share (EPS) over the next couple of years. Although the project's success is no way guaranteed, Albert believes that, if the money were spent to hire the software developer, the firm's sales and earnings would rise significantly once the two to three year development, production and marketing process was completed. With all these concerns in mind, Albert set out to review the various data to develop strategies that would help to ensure a bright future for Montage Software. Albert believed that, as part of this process, a thorough ratio analysis of the firm's 2016 results would provide important additional insights. Required 1. a) On what financial goal does Albert seem to be focusing? Is it the correct goal? Explain your answer. b) Could a potential agency problem exist in this firm? Explain. (1.5 Marks) 2. Calculate the firm's earnings per share (EPS) for each year, recognising that the number of shares issued has remained unchanged since the firm's inception. Comment on the EPS performance in view of your response to question 1a. (1.5 Marks) 3. Use the financial data presented to determine Montage's operating cash flow (OCF) and free cash flow (FCF) in 2016. Evaluate your findings in light of Montage's current cash flow difficulties. (1.5 Marks) 4. Analyse the firm's financial condition in 2016 as it relates to a) liquidity, b) activity, c) debt and d) probability, using the financial statements provided in Tables 2 and 3 and ratio data included in Table 5. Be sure to evaluate the firm on both a crosssectional and a time-series basis. (3 Marks) 5 BFA728 assignment RWC2016 5. What recommendations would you make to Albert about hiring a new software developer? Relate your recommendation here to your responses to question 1a. (1.5 Marks) 6 BFA728 assignment RWC2016 Table 1 Profit, dividend and retained earnings, 2010 - 2016 Montage Software Limited Year Net profits after taxes (1) Dividends paid (2) 2010 2011 2012 2013 2014 2015 2016 ($50,000) (20,000) 15,000 35,000 40,000 43,000 48,000 $2 0 0 0 1,000 3,000 5,000 Contribution to retained earnings [(1) - (2)] (3) ($50,000) (20,000) 15,000 35,000 39,000 40,000 43,000 Table 2 Income Statement ($000) Montage Software Limited For the year ended 31 December 2016 Sales revenue Less Cost of goods sold Gross profits Less Operating expenses Selling expense General and administrative expense Depreciation expense Total operating expenses Operating profits Less Interest expense Net profits before taxes Less Taxes (20%) Net profits after taxes $1,550 1,030 $520 $150 270 11 431 $89 29 $60 12 $48 7 BFA728 assignment RWC2016 Table 3 Balance Sheets ($000) Montage Software Limited 31 December 2016 Assets Current assets Cash Marketable securities Accounts receivable Inventories Total Assets Gross non-current assets Less Accumulated depreciation Net non-current assets Total assets Liabilities and Shareholders' equity Current liabilities Accounts payable Notes payable Accruals Total current liabilities Long-term debts Total liabilities Shareholders' equity Ordinary Shares (100 000 shares) Retained earnings Total shareholders' equity Total liabilities and shareholders' equity 2015 $12 66 152 191 $421 $195 63 $132 $553 $31 82 104 145 $362 $180 52 $128 $490 $136 200 27 $363 $38 $401 $50 $126 190 25 $341 $40 $381 $50 102 $152 $553 59 $109 $490 Table 4 Statement of retained earnings ($000) Montage Software Limited For the year ended 31 December 2016 Retained earnings balance (1 January 2016) $59 Plus Net profits after tax (for 2016) 48 Less Cash dividends on ordinary shares (paid during (5) 2013) Retained earnings balance (31 December 2016) $102 8 BFA728 assignment RWC2016 Table 5 Ratio Current ratio Quick ratio Inventory turnover Average collection period Total asset turnover Debt ratio Times interest earned ratio Gross profit margin Operating profit margin Net profit margin Return on total assets Return on equity Price/earnings ratio Market/book ratio Actual 2015 1.06 0.57 10.40 29.6 days 2.66 0.78 3.0 32.1% 5.5% 3.0% 8.0% 36.4% 10.5 4.1 Industry average 2016 1.82 1.10 12.45 20.2 days 3.92 0.55 5.6 42.3% 12.4% 4.0% 15.6% 34.% 11 4 9 BFA728 assignment RWC2016 Further notes for assignment completion. Please read these notes thoroughly. It is your responsibility to meet the requirements. Marks will be deducted for 1, 2, 3, 4 & 9 below. 1. Show workings, include all relevant steps and ensure that your final response is expressed in simplified form. You will not be penalised for consequential errors in calculations. 2. You will be penalised for poor interpretation and presentation of workings e.g. missing $ signs and 2 decimal points. 3. Assignments will not be accepted if not typed (including formulae and graphs). We recommend that you use computer software for word-processing and spreadsheet modelling. 4. Interpretation of calculations where requested will require a minimum of one paragraph. 5. Unless otherwise advised in writing, all work submitted for assessment must be completed by the student alone. While discussion of the topic is encouraged, no student is permitted to use any work of any other person and any material used from any publication must be acknowledged in full. 6. You must use the official TSBE cover sheet for the assignments. Your student number and student name should be included in the header or footer of every page of the assignment. 7. Any applications for extensions must be received by the unit coordinator before the due dates. Such applications will be treated on their merits. Work and family commitments do not normally constitute sufficient reason for the granting of extensions. 8. Please do not put your assignments in any type of folder. Just attach the coversheet to the front of your assignment with one binding e.g. one staple. 9. Bibliographies are required for assignments. You should acknowledge all references you used to assist you in completing the assignment. This includes your textbooks and your study notes. 10