Part 1 & 2

Part 1: The Ballwin Company was established 20 years ago to make footballs. It is now a leading producer of tennis balls, baseballs, footballs, and golf balls. Nine years ago, the company introduced "High Flite," its first line of high-performance golf balls. Ballwin management has sought opportunities in whatever businesses seem to have some potential for cash flow. Recently W. C. Meadows, vice president of the Ballwin Company, identified another segment of the sports ball market that looked promising and that he felt was not adequately served by larger manufacturers. That market was for brightly colored bowling balls, and he believed many bowlers valued appearance and style above performance. He also believed that it would be difficult for competitors to take advantage of the opportunity because of both Ballwin's cost advantages and its highly developed marketing skills. As a result, the Ballwin Company investigated the marketing potential of brightly colored bowling balls. Ballwin sent a questionnaire to consumers in three markets: Philadelphia, Los Angeles, and New Haven. The results of the three questionnaires were much better than expected and supported the conclusion that the brightly colored bowling balls could achieve a 10 to 15 percent share of the market. Of course, some people at Ballwin complained about the cost of the test marketing, which was $250,000. (As we shall see later, this is a sunk cost and should not be included in project evaluation.) In any case, the Ballwin Company is now considering investing in a machine to produce bowling balls. The bowling balls would be manufactured in a building owned by the firm and located near Los Angeles. This building, which is vacant, and the land can be sold for $150,000 after taxes. Working with his staff, Meadows is preparing an analysis of the proposed new product. He summarizes his assumptions as follows: The cost of the bowling ball machine is $100,000 and it is expected to last five years. At the end of five years, the machine will be sold at a price estimated to be $30,000. Production by year during the ve-year life of the machine is expected to be as follows: I Year 1: 5,000 units I Year 2: 8,000 units . Year 3: 12,000 units I Year 4: 10,000 units I Year 5: 6,000 units. The price of bowling balls in the first year will be $20. The bowling ball market is highly competitive, so Meadows believes that the price of bowling balls will increase at only 2 percent per year, as compared to the anticipated general ination rate of 5 percent. Conversely, the plastic used to produce bowling balls is rapidly becoming more expensive. Because of this, production cash outflows are expected to grow at 10 percent per year. First-year production costs will be $10 per unit. Meadows has determined, based on Ballwin's taxable income, that the appropriate incremental corporate tax rate in the bowling ball project is 40%. Net working capital is dened as the difference between current assets and current liabilities. Like any other manufacturing firm, Ballwin finds that it must maintain an investment in working capital. It will purchase raw materials before production and sale, giving rise to an investment in inventory. It will maintain cash as a buffer against unforeseen expenditures. And, its credit sales will not generate cash until payment is made at a later date. Management determines that an initial investment {at Year 0) in net working capital of $10,000 is required. Subsequently, net working capital at the end of each year will be equal to 10 percent of sales for that year- In the nal year of the project, net working capital will decline to zero as the project is wound down. In other words, the investment in working capital is to be completely recovered by the end of the project's life. Part 2: Ballwin has now reached the stage in which outside equity capital is necessary if the firm is to achieve its growth targets yet still maintain its target capital structure of 60% equity and 40% debt. Therefore, the management decided to take the company public. However, before talking with potential outside investors, Ballwin must decide on a dividend policy. Assume that you were recently hired by Ballwin to help prepare for its public offering. You were asked to make a presentation in which you review the theory of dividend policy and discuss the following questions: a. {1} What is meant by the term dividend policy? {2} Explain briey the dividend irrelevance theory that was put fonvard by Modigliani and Miller. What were the key assumptions underlying their theory? {3} Why do some investors prefer high-dividend-paying stocks, while other investors prefer stocks that pay low or nonexistent dividends? b. Discuss {1} the information content, or signaling, hypothesis; (2) the clientele effect; and {3} their effects on dividend policy. c. {1} Assume that SSC has an $800,000 capital budget planned for the coming year. Its present capital structure (70% equity and 30% debt) is optimal, and its net income is forecasted at $650,000. Use the residual dividend model approach to determine SSC's total dollar dividend and payout ratio. In the process, explain how the residual dividend model works. Then explain what would happen if net income was forecasted at $500,000 and at $750,000. {2} In general terms, how would a change in investment opportunities affect the payout ratio under the residual payment policy? {3} What are the advantages and disadvantages of the residual policy? (Hint: Don't neglect signaling and clientele effects.) d. What is a dividend reinvestment plan (DRIP), and how does it work? e. Describe the series of steps that most firms take in setting dividend policy in practice. f. What are stock repurchases? Discuss the advantages and disadvantages of a firm's repurchasing its own shares. g. What are stock dividends and stock splits? What are the advantages and disadvantages of stock dividends and stock splits? Question 1 (for Port 1) Determine using a full analysis of the project if the project should be undertaken. A positive NPV should be the decision criteria and the NPV should be calculated. An accompanying formulated Excel sheet should be submitted along a Word document with the explanation. Question 2 [for Part 2) Answer questions a through 9 above as thoroughly as possible