How to prove the question that How would the choice of financing method impact on the cost of capital and the value of the project? (With the Harvard business school case of Flash Memory, Inc. 20/August/2010) need to have calculation process to show the differences in cost of capital and project value.

Growth Projections

Based on the overall economic recovery and recent reports of robust sales of smart phones and net books, in early May the company was forecasting full-year 2010 sales of $120 million, with a corresponding cost of goods sold number of $97.32 million. Flashs projected year-end 2010 current asset investment necessary to support this level of sales and cost of goods sold was also prepared to assess the companys immediate financing needs.

Cash	$ 3,960,000
Accounts receivable	19,726,000
Inventory	13,865,000
Prepaid expenses	480,000

Total current assets $38,031,000

These forecasts of working capital requirements were based on sales in recent months, projected demand from OEMs, distributors, and retailers during the remainder of the year, and expected relationships between the income statement and these working capital accounts. Cash had been estimated at 3.3% of sales, accounts receivable were calculated based on an estimated 60 days sales outstanding, and the inventory forecast assumed the company would improve its inventory turnover, holding only 52 days of cost of goods sold in inventory.

Beyond 2010, the marketing manager had estimated that sales of the companys existing products would reach $144 million in 2011. It was expected that sales would be maintained at that level in 2012, but after that sales would decline to $128 million in 2013 and $105 million in 2014. In spite of the expected growth in the overall industry, Flashs product line would be less competitive absent new products which were significant improvements over previous offerings.

In addition to these income statement and working capital forecasts, there were other important items which would impact the companys forecasts and financing requirements. Purchases typically made up 60% of cost of goods sold, and the year-end 2009 accounts payable balance represented 33 days of purchases. This wasnt much greater than the 30-day payment period that Flash tried to maintain, but in 2010 and beyond the company was committed to achieve and maintain this number. The second of these items was research and development, which was planned to increase in 2010 to drive new product innovation. Research and development expenditures had been approximately 5% of sales in recent years, and in 2010 and beyond management was committed to maintaining expenditures at this percent of sales. Selling, general and administrative expenses were driven by sales volume and were expected to maintain their 2009 relationship with sales. Capital expenditures necessary to support existing product lines and sales growth were projected at $900,000 per year in 2010 through 2012. The final item was yearly depreciation expense, which was calculated as 7.5% of the beginning of year balance of property, plant & equipment at cost. A summary of these important forecast assumptions is included (Exhibit 3).

HARVARD BUSINESS SCHOOL | BRIEFCASES 3

4230 | Flash Memory, Inc.

Investment Opportunity

One of Hathaway Brownes primary responsibilities as CFO was to finance both the growth of Flashs existing product lines and all new investments that were approved by the board of directors. Investment proposals were prepared by the companys design, manufacturing, and marketing managers, thoroughly analyzed by Browne and the finance group, and then sent to the board for discussion, evaluation, and finally acceptance or rejection.

Browne had recently been given a proposal for a major new product line, which was expected to have a significant impact on the companys sales, profits, and cash flows. This new product line had been in development for the past nine months, and $400,000 had already been spent taking the product from the concept stage to the point where working prototypes had been built and were currently being tested. Flashs design and marketing people were very excited about this new product line, believing its combination of speed, size, density, reliability, and power consumption, would make it a winner in the fastest growing segment of the memory industry.

Customer acceptance and competitor reaction to the new product line was uncertain, but the projects sponsors were confident it would generate sales of at least $21.6 million in 2011 and $28 million in 2012 and 2013, before falling off to $11 million in 2014 and $5 million in 2015. The product was also believed to be superior to existing memory products, and would therefore command gross margins of 21% throughout its life.

Implementing this new product line would also require large investments and expenditures by the company. New plant and equipment costing $2.2 million must be purchased, and this specific equipment would be depreciated straight-line to zero salvage value over its five-year life. This depreciation expense all flowed to cost of goods sold expense, and was already included in the estimate that cost of goods sold would be 79% of sales. Flash also expected net working capital would be 26.15% of sales. This initial investment in equipment and net working capital would occur in 2010, and in subsequent years the net working capital would increase and then decrease, as sales of the new product line rose and then fell. SG&A expenses were expected to be the same percent of sales as the company experienced in 2009, but in addition the marketing manager also planned a one- time $300,000 advertising and promotion campaign simultaneous with the launch of the product in 2011.

Financing Alternatives

Although the loan officer of Flashs commercial bank had stated the company could obtain additional financing through their factoring group, a private sale of common stock was another financing alternative. Investment bankers had indicated to Browne that the company could issue up to 300,000 shares of new common stock to a large institutional investor at a price of $25.00 per share. After deducting the investment bankers fee and other expenses associated with negotiating and closing this private transaction, the company could expect to receive about $23.00 per share. Browne needed to analyze this proposed equity offering in comparison to the publicly traded common stock of a select group of competitors (Exhibit 4), and in comparison to Flashs forecasted results with and without a new equity offering.

The Net Present Value of investing new product line 2011 2014 2012 2015 2010 2013 New plant and equipment 2200 S21,600 S28,000 S28,000 S11,000 S5,000 Sales (generaing sell) S2877 S1.308 SO $7,322 $7,322 Net work capital $5,648 Investing in net working capital (changing in each year) -$5,648 1,674 $0 $4,446 $1,569 $1,308 $17,064 $22.120 $22.120 $B, 690 $3,950 Cost of goods Sold includes equipment depreciation SO SO $0 $0 SO Research & development ST 606 $2,341 S2,341. $920 $418 Selling, general & adminstrative S300 SO SO SO SO Advertising and promotion campaign cost S2.430 S3.539 S3,539 S1.390 S632 Income before income taxes $972 $1,416 $1,416 $556 $253 Income Tax $1,458 2,124 $2,124 S834 $379 After Tax (Net income) 440 440 440 440 440 Depreciation S1,898 S2,564 S2564 1,274 S819 Cash flow from operations Net cash flow -$7,848 S225 S2,564 $7,009 S2,843 $2,127 Net Present Value (NPV) $3,026 The Net Present Value of investing new product line 2011 2014 2012 2015 2010 2013 New plant and equipment 2200 S21,600 S28,000 S28,000 S11,000 S5,000 Sales (generaing sell) S2877 S1.308 SO $7,322 $7,322 Net work capital $5,648 Investing in net working capital (changing in each year) -$5,648 1,674 $0 $4,446 $1,569 $1,308 $17,064 $22.120 $22.120 $B, 690 $3,950 Cost of goods Sold includes equipment depreciation SO SO $0 $0 SO Research & development ST 606 $2,341 S2,341. $920 $418 Selling, general & adminstrative S300 SO SO SO SO Advertising and promotion campaign cost S2.430 S3.539 S3,539 S1.390 S632 Income before income taxes $972 $1,416 $1,416 $556 $253 Income Tax $1,458 2,124 $2,124 S834 $379 After Tax (Net income) 440 440 440 440 440 Depreciation S1,898 S2,564 S2564 1,274 S819 Cash flow from operations Net cash flow -$7,848 S225 S2,564 $7,009 S2,843 $2,127 Net Present Value (NPV) $3,026