How to make capital budgeting calculations? Differentiating between balance sheet information vs income statement information? Recommendations for accepting or rejecting a project? File is attached. Any help would be greatly appreciated. I do not have much experience with Finance.

A 1 2 READ 6 7 C D E F G VIDEOS 8 9 10 11 CASE 12 - Know the limitations of the k-wacc - Know how to interpret the decision metrics of capital budgeting: NPV, PI, IRR, PP Assignment questions are in the Q1 and Q2 tabs. 21 22 23 24 25 26 27 28 29 30 31 32 I J CFW Chapter 5 If you need a refresher on Time Value of Money, read Chapter 4 first. Capital Budgeting, the Most Used and Abused Finance Tool find links to the videos on the W7 Blackboard page The "Pesky" Weighted Average Cost of Capital Unravelling Net Working Capital Be Warned about NPV and IRR Flash Memory, Inc continued from W6 13 Learning Objectives 14 - Learn to use the classic capital budgeting process 15 - Appreciate the weaknesses of this process as well as its strengths 16 - Know how to calculate the weighted average cost of capital, k-wacc 17 18 19 20 H THE IS-BS MODEL AND FLOW DIAGRAM ARE INCLUDED FOR YOUR CONVENIENCE make hard copy in color if you have not done it already 3 4 5 B Week 7 Capital Budgeting I Observe spreadsheet conventions: Please notice how spreadsheet style conventions are observed in this box: Text does not run outside the box. Please get in the habit of writing your text in Excel this way, by hitting the ENTER key to skip to the next line, when your text fills the width of the box. Do not write in Word and then copy your text into Excel. INCOME STATEMENT Revenue Cost of sales Gross profit Other operating income Other operating expenses Total cost and expenses Operating profit (EBIT) Finance costs Profit before tax Income tax Net profit after tax Dividends Reinvested in the business BALANCE SHEET ASSETS LIABILITIES AND EQUITY Current assets Current liabilities Cash Trade payables Investments Other accruals Trade receivables Tax liabilities Inventories Short-term loans, leases Non-current assets Non-current liabilities Property, plant & equipment Loans, debt, leases due after 1 year Investment property Retirement benefit obligation Goodwill Deferred tax liabilities Total non-current liabilities COST OF DEBT K-WACC Equity & capital reserves Share capital Capital reserves Reserves Accumulated profits(Retained earnings) OPERATING LEVERAGE FINANCIAL LEVERAGE Total assets INCOME STATEMENT Revenue Cost of sales Gross profit Other operating income Other operating expenses Total cost and expenses Operating profit (EBIT) Interest, finance costs Profit before tax Income tax Net profit after tax Dividends Reinvested in the business WORKING CAPITAL spontaneous change with revenue ?what levels of ca, cl, s-t loans? CAPITAL BUDGETING ?what projects to accept? FINANCING ?what is the debt capacity? Total liabilities & equity BALANCE SHEET ASSETS LIABILITIES AND EQUITY Current assets Current liabilities Cash Trade payables Investments Other accruals Trade receivables Tax liabilities Inventories Short-term loans, leases Non-current assets Non-current liabilities Property, plant & equipment Loans, debt, leases due after 1 year Investment property Retirement benefit obligation Goodwill Deferred tax liabilities Total non-current liabilities COST OF EQUITY VALUATION CASH FLOW COST OF CAPITAL WORKING CAPITAL spontaneous change with revenue ?what levels of ca, cl, s-t loans? CAPITAL BUDGETING ?what projects to accept? FINANCING ?what is the debt capacity? COST OF DEBT K-WACC Stockholder's equity (Net worth) Preferred stock Common stock Additional paid-in-capital Retained earnings OPERATING LEVERAGE FINANCIAL LEVERAGE Total assets Total liabilities & equity COST OF EQUITY VALUATION CASH FLOW COST OF CAPITAL CREATION TRANSFER DESTRUCTION OF SHAREHOLDER VALUE THUMBNAIL SKETCH: FINANCING BRIEF ANALYSIS DEBT EQUITY DEBT DUPONT RATIOS HISTORICAL RAI/S & B/S FORECAST TIE NORMAL DEBT RATIOWORKING CAPITAL I/S, B/S, & RATIOS STOCK PRICE MKT CAP EXTENDED ANALYSIS FULL RATIOS LIQUIDITY LEVERAGE ASSET USE PROFITABILITY VALUATION GROWTH CAPITAL BUDGETIN OP & CAP NATCF, NPV, IRR, PAYBACK EFN ANALYSIS STEPS: 1-HISTORICAL RATIOS 2-K-WACC 3-CAPITAL BUDGETING 4-FORECAST & EFN 5-EQUITY VALUATION 6-FINANCING VALUATION EQUITY EBIT CHART income risk control mktblty flexblty timing K-WACC ENTERPRISE VALUE USING FREE CASH FLOW MARKET MULTIPLES: P/E, MV/BV, REV, EBIT Flash Memory, Inc. Exhibit 4 Selected Financial Information for Flash Memory, Inc., and Selected Competitors, 2007 through 2009 2007 Sales ($ millions) EPS ($) Dividend per share ($) Closing stock price ($) Shares outstanding (millions) Book Value per share ($) ROE Capitalization (book value) Debt Equity Beta coefficient Flash Memory, Inc. 2008 2009 30-Apr-10 (a) 2007 77 1.52 -n/a 1.492 11.43 13.28% 81 0.09 -n/a 1.492 11.52 0.78% 89 1.68 -n/a 1.492 13.20 12.75% 5,688 -0.42 -7.25 769.1 10.08 -4.13% 5,841 -2.10 -2.64 772.5 8.00 -26.21% 4,803 -2.29 -10.56 800.7 5.81 -39.43% 28% 72% 34% 66% 34% 66% n/a 24% 76% 31% 69% 40% 60% SanDisk Corporation Sales ($ millions) EPS ($) Dividend per share ($) Closing stock price ($) Shares outstanding (millions) Book Value per share ($) ROE Capitalization (book value) Debt Equity Beta coefficient Micron Technology 2008 2009 3,986 0.84 -33.17 227.7 22.64 3.70% 3,351 -8.82 -9.60 225.3 15.27 -57.74% 3,567 1.83 -28.99 227.4 17.18 10.63% 15% 85% 22% 78% 21% 79% 30-Apr-10 (a) 1.46 9.35 847.6 6.61 21.00% 33% 67% 1.25 STEC, Inc. 3.71 39.84 229.3 18.13 17.87% 19% 81% 1.36 189 0.20 -8.74 49.8 3.72 5.40% 227 0.09 -4.26 50.0 3.63 2.36% 354 1.47 -16.34 49.4 5.65 26.06% 0% 100% 0% 100% 0% 100% (a) Security analyst estimates for year-end EPS $ and Return on Equity; actual data on April 30, 2010, for all other items. 1.29 13.90 50.3 5.48 18.90% 0% 100% 1.00 Q1 Cost of Capital A 1 B C D E F Assignment Question Q1 2 3 4 Answers to the questions below will be found by closely examining the case. Detective work is required. If you uncover ambiguity (more than one possibility), mention both. 5 Formula 6 COST OF DEBT: Coupon Rate Marginal Tax Rate 10 Cost of Debt 11 weight of debt Equation 7 8 9 7.25% given 40.0% given 4.35% b5*(1-b6) 18% given k-d = I x (1- t) d d+e 12 13 14 15 16 17 18 COST OF EQUITY: Risk-Free Rate Risk Premium (Equity Risk Premium) Beta Cost of Equity weight of equity 3.70% given 5.00% given 1.20 given 9.72% b11+(b13*b12) 82% 1-b8 Weighted-Average Cost of Capital (k-wacc) 8.75% (b8*b7)+(b15*b14) (k-d x wt-d)+(k-e x wt-e) R-m - R-f k-e = R-f + [ x (R-m - R-f)] e d+e 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 118 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133 134 135 136 137 138 139 140 141 142 143 144 145 146 147 148 149 150 151 152 Q1a Find the sources of the numbers entered in B8, B9, and B11 and list them. 2007 Closing stock price Q1b Find the sources of the numbers entered in B14, B15, and B16 and list them. HINT: Case Exhibit 4 lists, among other information, betas for three peers of Flash Memory. B15 is assumed, but explain what CFW says about the foibles of the 'risk premium', AKA 'equity risk premium'. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 1 Page 5 Assignment Question Q2 The classic capital budgeting analysis for the new project line (page 4 of the Flash Memory case) is shown below. Read the 4 paragraphs under the Investment Opportunity subhead carefully. Most of the analysis is already completed. This assignment question requires you to examine the numbers and explain where they come from, and to enter the missing information in rows 29-33. CFW Chapter 5 explains the process, using the Generic Capital Budgeting Template. The Flash Memory template below is much shorter but contains the same information. ($000s) Investment in equipment Net working capital required (total from balance sheet each year) Investment in net working capital Sales Cost of goods sold (includes depreciation) Research & development Selling, general & administrative Launch promotion Income before income taxes Income taxes Net income Depreciation Cash flow from operations Total cash flow Cumulative total cash flow k-wacc NET PRESENT VALUE (NPV) PROFITABILITY INDEX (PI) INTERNAL RATE OF RETURN (IRR) PAYBACK PERIOD (PP) base year forecast years.......................................................................... 2010 2011 2012 2013 2014 2015 -$2,200 $5,648 -$5,648 -$7,848 -$7,848 $7,322 -$1,674 $21,600 $17,064 $0 $1,806 $300 $2,430 $972 $1,458 $440 $1,898 $225 -$7,624 $7,322 $0 $28,000 $22,120 $0 $2,341 $0 $3,539 $1,416 $2,124 $440 $2,564 $2,564 -$5,060 enter it from previous tab 2+ years by inspection Q2a Which rows contain balance sheet information? Which rows contain income statement information? Balance sheet: 13, 14, 15, 24, 25, 26, 27 Income statement: 16, 17, 18, 19, 20, 21, 22, 23 Q2b Explain the difference between the yellow-highlighted row 14 and row 15. In addition to digesting the details of Investment Opportunity (page 4), the 5th paragraph on page 2 and the 3rd paragraph on page 3 offer background on working capital. Q2c Explain the difference between rows 25 and 26. Q2d Explain the difference between rows 26 and 27. Q2e Enter the appropriate formula in B30, B31, B32. Q2f Recommend either accepting or rejecting the project, and explain your reasoning. Cite specific numbers. $2,877 $4,446 $28,000 $22,120 $0 $2,341 $0 $3,539 $1,416 $2,124 $440 $2,564 $7,009 $1,949 $1,308 $1,569 $11,000 $8,690 $0 $920 $0 $1,390 $556 $834 $440 $1,274 $2,843 $4,792 $0 $1,308 $5,000 $3,950 $0 $418 $0 $632 $253 $379 $440 $819 $2,127 $6,919