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Please Help Answer the Case Questions with formula and step by step process!!! CASE PROBLEM Houston Disbursement Betsy Cotner went to work for a title
Please Help Answer the Case Questions with formula and step by step process!!!
CASE PROBLEM
Houston Disbursement
Betsy Cotner went to work for a title com
pany after graduating from college. The
department she worked in provided dis
bursement advice to banks with regard to
oilgasrelated loans. When a bank
granted a construction loan, the money
was paid out according to progress made.
Someone had to monitor the project and
authorize disbursement of cash under the
loan agreement. While most banks moni
tor progress themselves, a few rely on out
side firms to do the monitoring, and this is
what Cotner's department did.
Cotner spent nearly a decade learning
the business and working her way up to as
sistant manager of the department. Then
a recession caused a decline in profits for
the title company. The title company de
cided to get out of oilgas disbursement,
and the department manager decided to
retire.
Cotner thought that there was still
enough business to make a decent living
for herself if she did not have to bear the
overhead cost of the title company. As she
informed the lenders of the title com
pany's decision, she also informed them
that she would be opening her own office.
She had developed an excellent personal
reputation, and several major lenders indi
cated a willingness to continue doing busi
ness with her. Thus, Houston Disburse
ment was born.
As the recession ended, Cotner's busi
ness picked up substantially, but she
began to worry about the vagaries of the
oil business. She decided to diversify into
general commercial construction in the
Houston area. She hired Brent Ross, a
young loan officer in the commercial con
struction field, with the understanding
that he could eventually buy an interest in
Houston Disbursement.
Cotner soon came to realize that she
had gained little from diversification. A
drop in oil prices caused the entire Hous.
ton economy to turn down, even when the
national economy was strong. Based on
her experiences, Cotner prepared an esti
mate of revenue and profits for Houston
Disbursement for both a strong and a weak
economy, and for both high and low oil
prices. Her estimates are summarized in
Table While the analysis focuses on
earnings before tax, this is approximately
the same as cash flow because capital in
vestments were limited to office furniture,
and net working capital was negligible. Net
working capital was kept negligible by the
practice of collecting retainer fees from
banks at the start of a construction project.
Cotner's salary, based on her estimate of
what she could get if she were working for
another company, is included in the cost
figures. The business was organized as a
Subchapter corporation and Cotner was
in a percent tax bracket.
To diversify, Cotner decided to open a
second office. She would go to the new lo
cation and promote Ross to manager of the
Houston office. Two possibilities that would
take advantage of her current contacts were
a commercial construction disbursement
office in San Francisco and an oil business
disbursement office in Alaska. Cotner was
quite willing to move to either area.
Cotner's estimates of profitability ap
pear in Table The costs include a fair
wage for Cotner; there would be no signif
icant wage savings at the Houston office
because a replacement for Cotner would
be needed.
Cotner considered high and low oil
prices equally likely. However, she be
lieved the probability of a strong economy
was twice that of a weak economy. She did
not believe a weak economy was likely to
last more than years. Low oil prices, on
the other hand, could continue for at least
years. Oil prices and the economy were
both strong at the moment.
It would cost approximately $ to
open an office in either San Francisco or
Alaska. The costs would be primarily de
velopment costs and would be expensed
for tax purposes. Fixed assets included in
this cost would be under $ and a
provision of the tax law allowed expensing
up to $ of fixed asset acquisitions.
Cotner had approximately $ in
vested in US government securities earn
ing percent, so she would have no diffi
culty in getting the $
Case Questions:
Compute expected return and stan.
dard deviation of annual return for
each alternative separately.
Compute covariance of annual re
turns between the Alaska and Hous
ton offices, and between the Califor
nia and Houston offices.
Compute the expected return and
standard deviation for each of the two
combinations.
Prepare pro forma statements for
each new office combined with the
Houston office, using each of the four
possible conditions.
What would you recommend to Cot
ner? Why?
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