Part 1 only

Woods Energy and Transportation Company

(WETC)

Part I

The day he was inaugurated, President Donald Trump issued his "America First Energy Plan."[1]It presented policies it said would "stimulate our economy, ensure our security, and protect our health" and thereby provide "a brighter future." Trump has promised that his energy policy will create "many millions of high-paying jobs."[2]

John Woods, the executive vice president and CFO of Woods Energy and Transportation Company, was very excited that the president energy plan would benefit his company. He immediately asked his Capital Budget Committee (CBC) to meet with him and his brothers to go over 10 projects representing $45 in capital expenditures from its two division.

The Company

Woods Energy and Transportation Company (Woods) is managed by the three Woods brothers, and Gorge Eriksen, son-in-law of the oldest Woods brother. Woods through its two divisions produces and markets coal and mineral primarily to utilities and industrial users and operates as a transportation company that provides truck and carrier services in the United States, Mexico, and Canada.

Energy Division

The energy division which is mainly in coal and mining produces a range of steam coals with varying sulfur and heat contents. The company operates 10 underground mining complexes in Illinois, Indiana, Kentucky, Maryland, and West Virginia. As of December 31, 2015, it had approximately 1.1 billion tons of proven and probable coal reserves. The company also leases land; and operates a coal loading terminal with a capacity of 8.0 million tons with ground storage of approximately 60,000 to 70,000 tons on the Ohio River at Mt. Vernon, Indiana. In addition, it buys and resells coal; and manufactures and sells rock dust. Further, the company offers various products and services, which comprise the design and installation of underground mine hoists for transporting employees and materials in and out of mines; design of systems for automating and controlling various aspects of industrial and mining environments; and design and sale of mine safety equipment, including its miner and equipment tracking and proximity detection systems.

Table1

Energy Division

Expand mining facilities at the Illinois

Expand mining facilities at Indiana

Special handling equipment for a mining operation in Indiana,

Special handling equipment for mining operation in West Virginia

Purchase of forklift for mining in West Virginia

Expand mining facilities at Kentucky

Expand mining facilities in Maryland

Transportation Division

The transportation division provides services to automotive, steel, oil and gas, alternative energy, and manufacturing industries, as well as other transportation companies who aggregate loads from various shippers. As of December 31, 2015, its fleet consisted of 2,166 in-service tractors and 6,054 in-service trailers.

Table 1

Transportation Division

Alternative plan for the Illinois is the expansion ofterminal freight

Purchase of ten new tractor-trailer for Kentucky operation

Purchase of ten new tractor-trailer rigs Maryland operation

Capital Budget Committee and Project Selection

The Capital Budget Committee at Woods is composed of Woods brothers and Eriksen. Typically, Woods solicit investment proposal from managing directors and if the project cost exceeds $500,000, it required the approval of CBC. For this year, the directors have recommended 10 projects which exceeded the capital expenditure limits. The Woods brothers have imposed a spending limit on the total investment and have mandated to not exceed the firm's internal funds.

With the new fiscal year, there was a need to determine which projects best fits the Company's future growth value enhancement. Thus, the challenge for the Committee was to allocate the funds among competing projects efficiently to increase the Company's value.

Table 1 and 2 provide a brief description of the projects and initial cost and the estimated cash flow of each project (after tax profit plus depreciation) over its estimated life.

Financial Information

At the end of 2015, the Company had net income of $79,893 and total asset was $1,017,032; consisting of $711,922, from to energy segment and $305,110 from transportation services.

On the basis of its net income, Woods wants to know how much money is available for capital investments as shown in Table 2. Its established common stock's dividend payout ratio after the preferred stock dividends payment is 50 percent of the funds. Currently the preferred stock has a 8 percent dividend yield with a par value of $100. A 12 percent cost of capital for funds generated internally has been used in the past, and Woods sees no reason to depart from this figure.Any additional funds used for capital budgeting purposes will have to come from external financing.In discussions with the Woods brothers, Woods informed them that any additional external funds will have a 14 percent rather than the 12 percent current cost of capital.

Questions:

1.How much of the internal fund is available for investments?

2.Which quantitative methods are useful to evaluate the projects?

3.Discuss the strengths and weaknesses of the quantitative methods you used to select the projects.

4.Which quantitative ranking results in the highest value to the company?

5.Are there any conflicts among the rankings of the projects? How do you resolve the conflict in ranking?

6.What project(s) should the CBC should recommend for the coming year based on 12 and 14 percent cost of capital?

7.Are there any issues about the projects that CBC did not consider before the recommendation?

Part II

The CBC has decided to finance all of the profitable projects based on its market capital structure but was worried that some of the projects have different risk than the firm's overall risk. CBC decided to gather public information about its two divisions as shown in tables 5 and 6. The Company has 20 million shares outstanding and its stock price closed at $31.45 per share on the first week of January, 2016.

Preferred stock is trading at a price of $80 per share with a dividend yield of 8 percent. The current debt was financed with 30-year long-term debt with a par value of $1,000 and was issued 10 years ago with a coupon rate of 8%.The current bond is trading at its par value. However the new debt financing will have a 20 year maturity with interest rate based on Treasury bond rate and risk spread of 4.4%.

1. Determine market value of the capital structures.
2. What is the equity cost of capital of each division?
3. What would be the Company's weighted average cost of capital before new financing?
4. What is the equity cost of capital after financing?
5. What is the Company's weighted average cost of capital after new financing?
6. Compare the expected rate of return of each project with each division equity cost of capital. Which projects should CBC recommend?
7. Is there any change in your recommendations if the comparison is made with the Company's weighted average cost of capital?

Table 2- Projects:

Energy

Transportation

Energy

Energy

Energy

Energy

Energy

Transportation

Transportation

Energy

Investment

($4,000,000)

($3,000,000)

($3,000,000)

($4,000,000)

($7,000,000)

($4,000,000)

($5,000,000)

($5,000,000)

($5,000,000)

($5,000,000)

Project Life

1

$750,000

$1,250,000

$550,000

$1,250,000

$1,500,000

$2,000,000

$2,250,000

$900,000

$1,500,000

$500,000

2

$750,000

$975,000

$550,000

$1,250,000

$1,500,000

$2,000,000

$2,250,000

$900,000

$1,400,000

$650,000

3

$750,000

$750,000

$550,000

$1,250,000

$1,500,000

$1,500,000

$2,250,000

$900,000

$1,300,000

$750,000

4

$750,000

$650,000

$550,000

$1,000,000

$1,500,000

$900,000

$1,000,000

$800,000

5

$750,000

$500,000

$550,000

$1,000,000

$1,500,000

$900,000

$750,000

$900,000

6

$750,000

$450,000

$550,000

$1,000,000

$1,500,000

$900,000

$650,000

$1,000,000

7

$750,000

$550,000

$1,500,000

$900,000

$500,000

$1,100,000

8

$750,000

$550,000

$1,500,000

$900,000

$450,000

$1,500,000

9

$750,000

$550,000

$900,000

$300,000

$1,750,000

10

$750,000

$550,000

$900,000

$300,000

$2,000,000

Table 3- Balance Sheet (in thousands)

31-Dec-13

31-Dec-14

31-Dec-15

Assets

Current Assets

Cash And Cash Equivalents

$18,177

$18,137

$18,097

Net Receivables

$123,978

$128,933

$133,889

Inventory

$111,169

$116,768

$122,366

Other Current Assets

$34,427

$31,569

$28,710

Total Current Assets

$287,752

$295,407

$303,063

Long Term Investments

$67,302

$72,332

$77,362

Property Plant and Equipment

$619,721

$642,100

$664,479

Goodwill

$10,238

$10,219

$10,200

Accumulated Amortization

($92,636)

($97,785)

($102,933)

Other Assets

$44,739

$54,801

$64,862

Total Assets

$937,115

$977,074

$1,017,032

Liabilities

Current Liabilities

Accounts Payable

$68,350

$74,749

$81,149

Current Long Term Debt due

$9,333

$9,833

$10,333

Total Current Liabilities

$77,683

$84,583

$91,482

Long Term Debt

$99,667

$120,667

$141,667

Other Liabilities

$12,726

$13,339

$13,951

Deferred Long Term Liability Charges

$82,184

$51,102

$20,020

Minority Interest

$1,202

$1,479

$1,756

Total Liabilities

$273,461

$271,168

$268,875

Preferred Stock (par $100, yield 8% and 1.25 million shares)

$125,000

$125,000

$125,000

Stockholders' Equity

Common Stock ( Class A owners,20 million shares)

$98,575

$74,435

$47,318

Retained Earnings

$429,870

$475,818

$524,743

Treasury Stock

$0

$0

$0

Capital Surplus

$128,902

$146,830

$164,758

Other Stockholder Equity

$6,307

$8,822

$11,337

Total Stockholder Equity

$663,654

$705,905

$748,157

Total Liabilities and Equity

$937,116

$977,074

$1,017,032

Table 4- Income Statement (in thousands)

31-Dec-13

31-Dec-14

31-Dec-15

Total Revenue

$1,030,798

$1,083,793

$1,136,788

Cost of Revenue

$550,044

$579,578

$609,112

Gross Profit

$480,754

$504,215

$527,676

Selling General and Administrative

$262,895

$272,787

$282,680

Others

$92,636

$97,785

$102,933

Operating Income or Loss

$125,223

$133,643

$142,063

Total Other Income/Expenses Net

$4,100

$5,055

$6,010

Earnings Before Interest And Taxes

$121,123

$128,588

$136,053

Interest Expense

$648

$789

$930

Income Before Tax

$120,474

$127,798

$135,122

Income Tax Expense

($48,190)

($51,119)

($54,049)

Minority Interest

($898)

($1,039)

($1,180)

Net Income From Continuing Ops

$71,387

$75,640

$79,893

Net Income

$71,387

$75,640

$79,893

Table 5- Trucking Industry Peer group

Stock

Symbol

Stock Market

Capital

Recent

Stock price

Enterprise

Value

Total

Debt

Equity

Beta

(Mil. $)

($)

(Mil. $)

(Mil. $)

Universal Truckload Services

UACL

838

29

1060

242

1.64

Celadon Group

CGI

529

22.73

804

321

1.35

Covenant Transportation group

CVTI

392

26.18

626

223

1.35

Heartland Express

HTLD

2410

22.47

2240

21

0.47

JB Hunt Transport Services Inc

JBHT

9950

1027

8920

840

0.91

Knight Transportation

KNX

3300

75.43

1870

38

0.81

Landstar System

LSTR

3300

74.53

3280

30

0.7

USA Truck

USAK

268

25.58

350

114

1.75

Werner Enterprises

WERN

225

221

1860

75

0.92

Marten Transport

MRTN

741

22.19

712

25

1.07

Table 6- Energy Industry Peer group

Stock

Symbol

Stock Market

Capital

Recent

Stock Price

Enterprise

Value

Total

Debt

Equity

Beta

(Mil. $)

($)

(Mil. $)

(Mil. $)

Arch Coal

ACI

982

5

4950

5150

1.97

Alpha Natural Resources

ANR

935

4

3420

3430

0.48

CONSOL Energy

CNX

9340

41

1219

3180

1.13

Cameo Corp

CCJ

8970

23

1064

1410

1.2

Peabody Energy

BTU

4360

16

9840

6000

1.5

Westmoreland Coal

WLB

420

28

695

340

0.11

Alliance Holdings Group LP

AHGP

3650

61

4400

886

0.51

Alliance Resources Partners

ARLP

3080

83

3830

886

0.65

Cloud Peak Energy

CLD

1260

21

1630

720

1.7

Walter Energy Inc.

WALT

463

7

2980

2780

1.56

TABLE 7 Total Annual Returns, 1926-2013

Investment

Average Return

Risk Premium

Large Stocks

11.70%

8.00%

Small Stocks

16.70%

13.00%

Long-term Corporate Bonds

6.20%

2.50%

Long-term Government Bonds

5.90%

2.20%

U.S. Treasury Bills

3.70%

0.00%

Modified from Stocks, Bonds, Bills, and Inflation: 2013 Yearbook,TM annual updates work by Roger G. Ibbotson and Rex A. Sinquefield (Chicago: Ibbotson Associates). All rights reserved.

Table 8- US Treasury Bonds Rates- December, 2016

Maturity

Yield

Yesterday

Last Week

Last Month

3 Month

0.02

0.02

0.03

0.01

6 Month

0.04

0.05

0.07

0.06

2 Year

0.45

0.4

0.42

0.3

3 Year

0.91

0.89

0.89

0.67

5 Year

1.73

1.69

1.71

1.47

10 Year

2.8

2.68

2.74

2.66

20 Year

3.6

3.53

3.61

3.63