Imagine your firm has some attractive investment opportunities that it is considering. The capital budgeting process has been completed and found that these projects have a positive NPV and are desirable. The firm must raise financing for the projects in the amount equal to 5% of the current level of its total assets. As you know, these funds can come from a number of sources: operations, short-term debt, long-term debt (new bond issues), or equity (new stock issues). Your task is to decide where funds for these projects should come from based on your knowledge of the firm and your knowledge of the current state of the economy (i.e., level of interest rates, state of the stock market, future prospects for the economy/firm).

The company EBITDA is 6,757 million

Your analysis should answer the following questions:

1. How much must your firm raise for the investments to be undertaken?

2. How will you determine where the funds should come from? Provide analysis for the following areas:

o Current capital structure of the firm, specifically, you must cite how some of the ratios you calculated in Part II will influence your decision.

o Federal Reserve policy and interest rates, meaning what are current borrowing interest rates and what direction do you believe these will trend in the near future?

o Stock price and state of the stock market, meaning are current stock prices high? Low? How could a firms financing choice(s) be impacted?

o Working capital policy

o Profit/loss situation and operating cash flows

Format:

Your Firm's Current EBITDA:

$ 15,250

Cell F2 is dynamic; put in your company's EBITDA

Step 1:

Acquisition Target's EBITDA:

10%

$ 1,525

NOTE: Problem gives you cost of debt and equity and WACC

Read instructions as rates are given to you

You will be required to figure out what % is equity vs debt (back into these numbers!).

Step 2:

% Component

$ Amounts

Similar calculations as in WACC assignments

Equity in deal

Debt for deal

Step 3:

Calculate Loan Payment schedule (you will need "P" and "I" for each yr);

Create A loan amorization schedule for you loan

My preference is that you do this yourself but you may see sheet below

Step 4:

Calculate depreciation

Straight forward calculation (and all pun intended here!)

Calculate amortization (of goodwill.if goodwill was created in the transaction).

Goodwill is created if your purchase price for the entity is higher than the value of the assets purchased.

For this analysis (*), amortize your goodwill on a straight-line basis for 25 yrs

(*) This step is not the current "law in the land"but worthwile exercise

Goodwill is the amount one pays above the actual value of asset

Buy a company for $100; assets include one machine worth $70 and a 3 yr contract to deliver parts

Contract is actually a piece of paper.so goodwill is created in this example

Step 5:

Assume the entity survives in perpetuity; however, you are to assume the values of yrs 10 to infinity are incorporated in a 2 X EBITDA value in yr 10

Valuation Trick is to put some number (2X here) to represent all future activities.

At some high (but relatively low) discount rates, years 11 through infinity truly represent pennies in a PV calculation.

Step 6:

Create an Income statement.then extend this to an After Tax Cash flow statement

Yr

0

1

2

3

4

5

6

7

8

9

10

All numbers below are made up as an example only)

Purchase Price

(4,580)

EBITDA (no Growth)

572.5

572.5

572.5

572.5

572.5

572.5

572.5

572.5

572.5

572.5

Int Exp

Dep Exp

Amort Exp

Gross Profit

Taxes

Net Income

After Tax Analysis:

Net Income:

Add: Dep

Add: Amort

Less: Principal

Less: CapEx (assume $0)

After Tax Cash flow=

The above is the accounting set up for the analysis below

Financial Analysis:

Use purchase price, and after tax cash flows with your required rate of return (which rate? You need to select correct one) to get NPV and IRR answers.

Do you buy? Yes or no?

Perform the above analysis againthis time assume 100% equity (no debt; remove all cash flows due to debt).

Calculate NPV and IRR here; does this answer differ from the above?

That is, if leverage is the only reason to buy something, is that a good decision?

Loan format:

								Footnotes for Below:
	Loan Balance (From other sheet)							1	Loan Balance at end of Period is identical to loan Balance at beginning of next period
	Interest rate							2	Interest (expense) is annual interert rate times CURRENT LOAN BALANCE
	Term (see instructions)							3	Payment is same as cell G6
								4	Calculate by taking Payment less Interest for period
	Caculate Pmt
	Period	Loan Balance At Period Start	Interest For Period	Payment	Princ Portion which reduces loan	End of Period Loan Balance
Footnotes		1	2	3	4	1
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