Itwas a Fridaynight,andyouwere sittingalone insome IrishbaronCrescentStreet.Montrealwas still Montreal, yetyourlife wasn'tas easyas itwas whenyouwere a student.Theloudmusiccouldn'tcheer youup.Allyou could think ofwasyourangrymanageratworkandyoujustwantedtogetwasted. Suddenly,you heard afamiliarvoice.ItwasXiao Ming,afriendyou had whenyou wenttoschoolat JMSB.Althoughyouhaven'tseen eachotherforafewyearsaftergraduation,you caughtupwith each otherprettywellandlaughedaboutthose days whenyourockedthe GuitarHerointhe basementofyour mom's house...A few days later,youreceiveda callfromXiaoMing.Itturnedoutthathis dadpassed awayand lefthimafortune,and Xiao Ming isnowtheboard directorand theCEOofa Companycalled "NO-CAN-NO-BB"(NCNB),and hewould liketo offeryou theposition ofCFOthere."Irememberyou were reallygoodatFINA 395" he winked.Aftersome paperwork,youwere hiredas the CFO,andyourfirstjobwas toevaluate a new projectthat the firmis consideringcalled"YOU-CAN-YOU-UP"(YCYU).Sittinginyourspacious corneroffice, you couldn'tgetovertheideathatpeopleweretalking behindyourback thatyou only gotthejob because youknewtheCEO.Youcalledyourassistantforthecase files,anddecidedtoworkallnightandshow yourcolleaguesthatyouarenotwho they thoughtyouwerein themorningmeeting ofthefollowing day.NCNB isa Canadianproviderofstreamingmovies andTV shows,justlike Netflix.YCYU is the proposed projecton theexecutives'table.In thisproject,thecompanyisplanning to investinanewtalk show called"TheBBKing" thatis exclusivelyofferedonNCNB,justlike watchingHouse ofCards on Netflix.Yourstaffin theCapitalbudgeting departmenthasalreadycollected enough information,now yourjob astheCFOisto determinewhetherthecompanyshould investin thisnewproject.Afterarefillofcoffee,yousorted thefollowing information fromthefilesinordertodetermine the appropriatediscountratethefirmshouldemployforitsnewproject:NCNB isnowselling for$20pershareand ithas14million outstandingcommon shares.The company hasanequityof0.94. Adividendof50centswasjust paidto allofthecommon shareholdersand analysts estimate thatitwillgrow steadilyat5%peryear.As forthe preferredshares,there are 1.5 million sharesoutstanding,each ofwhich isselling at$25 with a$2.5 dividend.Thefirmhasan AA rating bond currentlyquoted at110.Couponrateis9%with semiannualcoupons.Thereare75 thousand outstanding bondsand timetomaturityis15years. Besidesthat, youobservetheofthreecompanies thatfocusonproducing talk shows,such astheConan Show,theEllen show,and theChrisRock show. Theseare1.35,1.07, and1.24. Theexpectedmarkerreturnis6.4%, thecurrentrisk-free riskrate is 1.9%,and thecorporatetax rateis40%.

Creating thePro FormaStatementofComprehensiveIncomeforthenewprojecttookyou alotlonger thanyou expected;5 hoursflewbybeforeyou realized it.You turned aroundand lookedthroughthe window,itwasalmostdawn.Sitting inthechairforsuch along timemadeyourmuscleso sourthatyou hadtostandupanddosome stretches.While makingsomemorecoffee,youwitnessedthe mostbeautiful sunriseinyourlife. Withabittersmile,you turnedoffthelights,and wentbackto work.Therewasnot much timeleftbeforethemorningmeeting,you neededto focusonestimating thecash flowsfromthe following accounting termsyou justsorted out.Theprojectisexpected to last4 years.Thecompanyisplanningtospend $2 million on fixed assetssuch asthefilming equipments.Xiao Ming hasalreadyspent$100,000on consultancy to check thefeasibility oftheproject.Thereisan idlestudio thatthecompany boughtafewyearsago.Theoperationmanager suggested thatthestudio isperfectto filmtheBBKing,anditisworthyof$400,000 ifitissold on markettoday.Theprojected salesforthe4yearsare$1 million,$1.7 million,$1.6 million,and $2 million.Thevariablecostis50%oftheprojected sales,and thefixed costis$500,000 foreveryyear.The companyalsoestimates itsincreases ingross profitfromotherexistingprojects tobe $5million,$3 million, $4million, and$6millionforyear1,2,3,and4,respectively.Yourteamthinks20%,50%,30%, 10%ofthese increases ingross profit,respectively,are due tothe introductionofYCYU.Theinitialnet working capitalisgoing tobe$150,000,NWCincreasesby200,000foryear1,decreasesby75,000 for year2,increasesby120,000 foryear3,and increasesby50,000 foryear4.Thecompanyisexpecting to recover80%ofitsinitialNWCattheend oftheproject.Supposeboth thestudio and thefilming equipmentsbelong to class8,and subjectto an annualCCArateof20%.,and thetotalcapitalspending isestimated to haveasalvagevalueof$1.1 millionattheend oftheproject.

Question1:What istheNPV of thisprojecttoday?CalculatetheWACCandanappropriateinterestrateusing pureplaymethod,andtake the simple average ofthe twoas the appropriate discountrate for the project.Use the CAPMmodelfor common sharesand thedividend growth Modelfor the preferredshares whencalculatingthe costofequity.Use theEAR, nottheYTM, whencalculatingthecost of debt.(Youwillfind howto dothesein myTopic10 COMM 308 lecturenote)Presentyouranswerswith theTaxShield Approachon an Excelspread sheet,ofwhich you can findan exampleon Page13ofmyTopic2FINA395lecture note.

Althoughexhausted,you earned otherpeople'srespectin themorning meeting.Xiao Ming wasespecially happyanddecided to askyouropinion on thechoiceofhiscompany vehicle.Henarrowed down his choices totwocars,Tesla ModelSandMercedes-BenzCLS.Once the choice ismade,assume the companykeeps buyingthesame typeofcaras soonasits usefullife is over.AlsoXiaoMingthinks these twocars give himthe same levelofpleasure,thus italldepends onthe annualizedcostofthe car.

TheTesla ModelScosts$100,000 initially,theoperating expensestotalto $15,000 peryearand hasa4yearlife, afterwhichit will sell for$15,000. TheMercedes-Benz CLSon theotherhand costs$85,000 initially,theoperating expensestotalto $17,500 peryearand hasa3-yearlifeafterwhichit will sell for $10,000.TheCCA rate is 40%,andyouassume a requiredrate ofreturnof12%inthis case.

Question2:WhataretheEACofthesetwo carswhiletaking Taxand CCAtaxshield into consideration? Which carshould you recommend to Xiao Ming basedon yourfindings? You need toshowmehowyou calculate the numbers,the Excelspreadsheetis notnecessary for this question.

Xiao Ming seemed to bepleased byyourrecommendation ofthecompanycaroverthelunch break... unexpectedly,youruptightassistantHannahknockedon yourdoorwhen you wereenjoyingyour afternoonnap.She was a little nervous whenshe recommendedyoutorefineyourreportonthe capital budgetingofthe new projectwithsomesensitivityanalysis.Youwere amazedbyyourcourageous assistantwhoturnedouttobeloyalandhelpfulinthefollowingyears.

Questions3:AsHannahsuggested,theNPVcanbe sensitive tothe estimationsofdiscountrateand the cashflows.Youdecidedtorecalculate the NPVwithaworse casewhere the projectedsales are 75%of whatyour staffestimated,andwithaworstcase where the projectedsales are 50%ofwhatyour staff estimatedbefore.(This should beafewclicksawayifyou managedto figureouthowto do calculation withExcelspreadsheetfrom the lasttwoquestions)In addition,plota graphforNPV(Y-Axis)and thediscountrate(X-Axis)usingExcelto showthe sensitivityof NPV tothechangeindiscountrate.Youonlyneed toperform the analysisfortheoriginalcase(Do not changethecash flowsbutchangethediscountrateinthiscase) ...

Time reallyflew.The YCYU projectturnedouttobe a huge successwithHannah's help.Standingby the samewindow,you foundyourselfsmiling.Thesun feltwarm...looking up,yousaid toyourself,"I mighthavejustfound myplacein thisworld,Dad".In mostHollywood movies,itshould allendsup here,andyouliveyourlifehappilyeverafter.Well...wedo not liveinthemovie, andlifeismuchmore dramatic.Shockingnews came toyouthatXiaoMingandhis Frenchactress girlfrienddiedina car accident.Apparently,theywere driftingthe caryourecommended.The boardofdirectorelecteda new CEO and outofblue,youwerefired.Luckily,youdeveloped somecontactsovertheyearsin NCNB,and aguyfromIveySchoolofBusinessin University ofWestern Ontario called you.Hesentyouthe followingMini-Caseto testyourpotentialto teach in oneoftheaffiliatedcollege inUWO.Afterreading thisemail,you pouredyourselfsomecoffee.Lookingatthemoon outside,youpacked upyourdepressive mood and said toyourself"Here we goagain...No pain,nogain;no guts,noglory".