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FIN303 Financial Management Assignment 2 - Individual Assignment/ TMA02 January 2016 Presentation FIN303 Assignment 2 Individual Assignment This assignment is worth 25% of the final mark for FIN303 Financial Management. The cut-off date for this assignment is 25 April 2016, 2359hrs. ___________________________________________________________________________ Protect IT is a company that makes protective cases for smart phones such as the iPhone. The company is considering a proposal to expand its product selection to include protective covers for tablet devices like the iPad and so far, the firm has spent $10,000 analysing the potential market for such a product. Management believes that many purchasers of cell phone cases will also buy tablets, and so the company has a built-in clientele for the new product line. If the company decides to undertake this project, it will begin selling new products next month when its new fiscal year begins on January 1, 2016. The company would therefore make the required investment before the end of the current fiscal year, that is, 31 December 2015. The financial statements of Protect IT for the years 2014 and 2015 are given in Table 1 and Table 2. The management would like to understand its financial performance in 2015 relative to the industry. The ratios for the industry are given in Table 3. Table 1 Balance Sheet as at December 31 (Figures in Thousands) Current Assets Cash and Cash equivalents Marketable Securities Accounts receivables Inventories Prepaid Expenses Total Current Assets Fixed Assets Gross Property, Plant and Equipment Less: Accumulated Depreciation Net Property, Plant and Equipment Intangible assets Net fixed assets Total assets Current Liabilities Accounts Payables Notes Payables Accrued Expenses Total Current Liabilities Longterm Liabilities Deferred Taxes SIM UNIVERSITY 2015 2014 440 35 1,619 615 170 2,879 213 28 1203 530 176 2150 9,920 3,968 5,952 758 6,710 9,589 9024 3335 5689 471 6160 8310 1,697 477 440 2,614 1304 587 379 2270 907 793 Assignment 2 - Page 2 of 6 FIN303 Assignment 2 Long term debt Total long term Liabilities Total Liabilities Stockholder Equity Preferred Stock Common Stock ($1 par) Paid in Capital in excess of par Retained earnings Less: Treasury Stock Total Stockholder Equity Total Liabilities and Stockholder Equity 1,760 2,667 5,281 1,474 2,267 4,537 30 179 442 4,271 614 4,308 9,589 30 185 386 3,670 498 3,773 8,310 Table 2 Income statement for the year ending 31 December (Figures in Thousands) Sales Revenue Less: Cost of goods sold Gross profit Less: Operating and other expenses Less Selling, General and Administrative Expenses Less Depreciation Operating Profit Plus: Other income EBIT Less: Interest Expenses Pretax Income Less: Taxes Current Deferred Total Taxes Net Income Less Preferred dividends Earnings available for common stockholders Less: Dividends To Retained Earnings Per share data EPS DPS Price per share Number of shares Credit purchases (million$) SIM UNIVERSITY 2,015 12,843 8,519 4,324 1,544 616 633 1,531 140 1,671 123 1,548 2,014 9,110 5,633 3,477 1,521 584 608 764 82 846 112 734 367 232 599 949 3 946 345 601 158 105 263 471 3 468 326 142 5.29 2.52 1.93 1.76 76.25 71.50 178,719,400 185,433,100 6,815 4,506 Assignment 2 - Page 3 of 6 FIN303 Assignment 2 Table 3 Industry Ratios Ratios Current ratio Quick ratio Inventory Turnover Average Collection Period Average payment period Fixed Asset turnover Total asset turnover Debt ratio (Total liabilities/total assets) Assets/equity ratio (Equity Multiplier) Longterm debt to stockholder equity Times Interest Earned Ratio Gross profit margin Operating profit margin Net profit margin Return on total assets Return on common equity Industry average 1.23 1.02 16 42 100 1.6 1.42 38.65% 1.63 30.00% 16.25 40.00% 12.00% 8.50% 12.10% 19.70% With respect to the new product introduction, the following information is obtained: Up-front costs include $50,000 in computer equipment. This equipment will be depreciated over 5 years on a straight line basis and will have no salvage value at the end of 5 years. The managers believe that the average selling price of the new tablet covers to be at $13.50 and they expect that the price will remain constant indefinitely. Managers expect unit sales volume to start at 4,500. It is also estimated that the sales volume will increase by 10% a year from year 2 to year 5. From year 6 onwards, the sales volume will increase at a constant rate of 4% every year. The cost of goods sold will be 72% of sales revenue with selling, general, and administrative expenses at 10% of sales. No additional fixed asset investment will be necessary to support the increased sales. At the start of the new project, Protect IT needs to provide $ 6,000 worth of working capital. Subsequently, as sales grow, Protect IT will make additional investments in inventory and receivables. Each year, accounts receivables will be equivalent to one-month sales, and inventory balances will be about 12.5% of sales. Protect IT's suppliers will provide trade credit on terms such that the accounts payable balance will equal about 10% of cost of goods sold each year. By the end of year 5, the sales of the tablet covers will reach a steady state and cash flows will grow at 4% a year indefinitely from year 6 onwards. SIM UNIVERSITY Assignment 2 - Page 4 of 6 FIN303 Assignment 2 The beta of the company is estimated as 0.8. The risk-free rate is 3% and the market risk premium is 6%. Tax rate will be 20% for the project income The company has a target debt ratio of 40%. It can raise debt at 8%. Question 1 Compute the following ratios for 2015. Ratios Current ratio Quick ratio Inventory Turnover Average Collection Period Average payment period Fixed Asset turnover Total asset turnover Debt ratio (Total liabilities/total assets) Assets/equity ratio (Equity Multiplier) Longterm debt to stockholder equity Times Interest Earned Ratio Gross profit margin Net profit margin Return on total assets Return on common equity Industry 2015 Average 1.23 1.02 16 42 100 1.6 1.42 38.65% 1.63 30.00% 16.25 40.00% 8.50% 12.10% 19.70% (15 marks) Question 2 Analyse the difference in the ROE of Protect IT and the ROE of the Industry in 2015 through the relevant ratios. (20 marks) Question 3 Calculate the weighted average cost of capital for the project. (15 marks) SIM UNIVERSITY Assignment 2 - Page 5 of 6 FIN303 Assignment 2 Question 4 Calculate the initial investment on December 31, 2015. (10 marks) Question 5 Calculate the cash flows for the years 2016 to 2020. (20 marks) Question 6 Calculate the terminal cash flow at the end of year 2020. (10 marks) Question 7 Calculate the net present value of this project and recommend whether the project should be undertaken. (10 marks) ---- END OF ASSIGNMENT ---- SIM UNIVERSITY Assignment 2 - Page 6 of 6