Mr. Entrepreneur's Story, continued... Part 1 Because of his business acumen and an element of luck, ABC Corporation has been doing really well and has become one of the major players in baby furniture industry in North America. Due to its rapid growth, the demand for capita for ABC Corp. is getting more urgent as days go by. Mr. Entrepreneur and his leadership group of the company now are very seriously Page 1 of 11 Final Assessment - Mr. Entrepreneur's story continued... reconsidering the idea of taking company public i.e., selling a part of ownership of the company to the public in order to raise the needed capital for company growth. Mr. Entrepreneur rehired the brokerage firm he had consulted previously and wanted some help from them with respect to all aspects of "going public" for the company. The term for this activity in the investment business is called "IPO" - initial public offering". One of the major steps in a successful IPO is to price the company share properly. The company's instinct is to price the shares as high as possible so that company can raise a lot of capital from the stock selling. But if the price is set too high, the demand for the stock is going inevitably weak. However, if the share is priced too low, then the company is not going to achieve its fund-raising objectives. Therefore, the trick here is to price the company stock at such a price that is low enough to attack a lot of buying interest in the market, also it is high enough so that company can raise enough funds to meet its growth needs. The first step to perform a valuation of the company stock is to collect company data with respect to its earnings and growth. Then we can do some research regarding how the market is evaluating similar companies in the market. Eventually company can come up a share price that satisfies its needs. The following data are available (both real and projected): The earning growth rate is projected at 30% for the first four years; After that, the growth rate will become more reasonable at 7% per year for the foreseeable future. The 40% of earning was paid out as dividend for year 2019 (From Income Statement). The dividend will be increased at the earning growth rates. The required rate of return (discount rate) is 12.5%. Page 2 of 11 Final Assessment - Mr. Entrepreneur's story continued... In addition to the calculated share price based on real/projected data, there are a number of other important factors to consider in order to make IPO a success. These factors include, first of all, the general market performance. In general, IPO is less likely to be successful in a bear market than in a bull market environment. So, the timing of taking a company public is very important. The second factor is the performance of the industry the company is in. If financial performance of the companies in the same industry is performing well then, your IPO is most likely to be a successful event. Otherwise, you would have harder time to raise money. Part 2 The IPO turned out to be a great success. ABC Corporation raised $10 million in the process. Mr. Entrepreneur was very excited about the fund raising and looked forward to investing the raised funds in some future projects that would help the company move to the next level. Mr. Entrepreneur called in his Vice president in Finance, Mr. Financer, asked him to prepare some investing alternatives for the company leadership to decide. Mr. Financer came back with three investment proposals: The first proposal is to add 5 trucks to company's delivery fleet. The cashflow of the addition of trucks is projected as follows: Investment proposal \#1 - adding 5 trucks Final Assessment-Mr. Entrepreneur's story continued... The second proposal is to purchase a more advanced wood crafting machine. The projected revenues and costs and changes in net cash flow are summarized in the table below: Investment proposal \#2 - adding a wood crafting machine: The third proposal is to add a new production line making new type of baby furniture. The projected increased revenues and costs and net changes in cash flows are summarized in the table below: Investment proposal \#3 - adding a new product line: Mr. Entrepreneur was very excited about the investment proposals. He was very anxious to know which projects they are going to pursue in the near future. Since he has very little training in capital budgeting, he needs some help in selecting the most promising project(s). Questions: (Total 95 marks) 1. In your opinion, should Mr. Entrepreneur only tap into domestic market in Canada by listing company shares on TSX? Or should he try to tap both domestic and US markets by listing his company shares both on TSX and NYSE (a dual listing)? Explain your answer. (5 marks) 2. What is the difference between Primary and Secondary market? Using Mr. Entrepreneur's IPO as an example, describe the main function of Primary and secondary market? (6 marks) Final Assessment - Mr. Entrepreneur's story continued... 3. In Canada, setting and enforcing market regulations are provincial responsibilities. However, in most other western countries, such as USA, Japan, regulating capital market is under federal jurisdiction. Do you think Canada should change and make regulating capital market a federal mandate? Why? (6 marks) 4. Use the most appropriate valuation model to calculate the expected share price of ABC Corporation using all the variables provided on page 2 . (Keep 4 decimal points for intermediate calculation and round your final answer to two decimal points) (15 marks) 5. Some financial analysts use P/E ratio to estimate the share price. Comment on this approach by listing advantage and disadvantage of this approach. (5 marks) 6. Among all the capital budgeting analysis methods you have studied, in your opinion, which method is the most popular and reliable method? Explain why? (10 marks) 7. With respect to what discount rate the company should use to discount its future cash flows, two opinions emerged: one suggested they should use the required rate of return for the individual projects. The other advocated using the company overall Weighted Average Cost of Capital. What is the Weighted Average Cost of Capital (WACC)? In your opinion, which rate is more appropriate and why? ( 6 marks) 8. As a consultant to Mr. Entrepreneur, you are asked to rank the investment proposals proposed by Mr. Financer using Payback Period method. Which proposal should be selected? What is the chief disadvantage of this method? Why would anyone want to use this method? (Please show your calculation, round your answer to two decimal points) (12 marks) 9. Again, as a consultant to Mr. Entrepreneur, you are asked to rank the proposals by using IRR (Internal Rate of Return) method. Which project should be selected under IRR approach? What is the main shortcoming of IRR approach? (Please identify all the variables you use in your calculation when you use a calculator. Round your final answer to two decimal points. Ignore all CCA effect on cash flow). (15 Marks) 10. Finally, use NPV (Net Present Value) method to rank the investment proposals and select the most appropriate one to pursue. What is the most challenging aspect of the NPV method? (Please identify all the variables you use in your calculation when you use a calculator. Round your final answer to two decimal points. Ignore all CCA effect on cash Final Assessment-Mr. Entrepreneur's story continued... Table 1 - Statement of Financial Statement Page 8 of 11 Final Assessment - Mr. Entrepreneur's story continued... Table 2-Statement of Income Table 2-2 Alternative Statement of Income Page 9 of 11 Final Assessment-Mr. Entrepreneur's story continued... Table -3 Statement of Cash Flow Page 10 of 11 Table 4- Industry Statistics Table 5 - Major baby furniture maker comparison