Summer Corporations CEO Mohamed is a brilliant marketer and salesman, he can close any deal with any customer. He is also the founder of the company since 2019. However, he is not knowledgeable in corporate finance. He usually just picks projects with the greatest after-tax income forecast. He recently came across four potential projects. Due to the size of the staff, he can only pick one to focus on. Combining Summers industry requirement with its capital structure, the companys current weighted average cost of capital (WACC) is 15.4775%. Su-Jin, the newly hired CFO, is tasked with making the forecast of the projects (See Figures 1-4.) Su-Jin has been wanting to make the project selection process (capital budgeting) more financially advance and educate Mohamed on the benefits and disadvantages of the different corporate finance methods. The methods she wishes to use are: Total after tax income, payback period, internal rate of return (IRR), and net present value (NPV.) Su-Jin realizes the company can reduce its WACC by changing its capital structure. She wants to present this idea to Mohamed as well. Currently Summer does not employ any long-term debt. It was originally financed in 2019 with 90% common stock (CS) and 10% callable preferred stock at (Callable at Par Value, PF.) CS current estimated price in 2020 is $20 (Treat this as Price 0). CS just paid an annual dividend of $1.9 in 2019 (Treat this as dividend 0.) Its expected dividend growth rate is 5%. PF is paying a 20% annual dividend. Su-Jin has negotiated three possible bank loans where the pre-tax annual interest rates are: 6% if it comprised of 20% of the capital structure, 8% interest if 30%, and 10% interest if 40%. Summers corporate tax rate is 33%. Based on experience Su-Jin wants to keep Summers Debt to Total Asset ratio below 0.35. During her research, she found the risk-free rate to be 2% (Expected to be the same in 2021,) and the market return to be 5% (Expected to the be same in 2021.) Su-Jin must re-calculate the new WACC to select the proper capital structure based on the loan terms, desired Debt to Total Asset ratio. She must also adjust 2021 capital structure (buy back CS and/or call PF.) The previous CFO did not finish the financial statements. One of the urgent tasks for Su-Jin is to create financial statements since the companys inception in 2019. Su-Jin was handed incomplete accounting information from 2019-2021 (2021 is forecasted, see Figure 5.) She will have to use the incomplete information to deduct the missing numbers. Historically gross margin for the company is 50% and will project into 2021. The 2021 forecast included estimation of the project but not the new capital structure. There is no need to recalculate 2021 numbers with the project information. Su-Jin will want to incorporate the new capital structure into creating the financial statement of 2021. Su-Jin will present capital budgeting, capital structure and financial statements to Mohamed very soon.

1. What is the cost of common stock in 2020?

a. Calculate its beta based on Capital Pricing Model

b. Comment on Summers beta in relation to the industry and the overall market. The industry average beta is 2.

2. Prepare a table of new WACC with all three loan terms, present the lowest WACC of each loan by adjusting the capital structure. Include the weights and the weighted cost of each component (Debt, CS and PF.)

3. Which capital structure should be selected based on the information in the case?

4. Create Balance Sheet and Income Statement from 2019-2021 based on numbers in Figure 5 without Long Term Debt. Round items in financial statements to nearest dollar.

5. Revised 2021s Balance Sheet and Income Statement with the new capital structure. Analyze the original and revised statements to see if company performance is improved. Include comparison of profitability, and debt utilization ratios between the original and revised statements. Include discussion of the change in dividend payments. Correct any changes in addition to retained earnings with the new structure by adjusting cash and keep other Asset items unchanged from original forecast. Use 2020 cost of CS to estimate 2021 CS price. Round items in financial statements to nearest dollar.

2021 2022 2023 2024 2025 $ 3,655 $ 8,000 S 10,000 $ Figure 1 Financial analysis of Project A Initial Expenditures Net cost of new fixed assets $25,000 Additional revenue Additional operating costs Depreciation Net increase in income 25,000 $ 22,000 $ 500 $ 500 $ 500 $ 500 $ 500 $ 3.600 $ 5.280 S 5,040 $ 5.670 $ 5.670 $ (445) $ 2,220 S 4,460 18,830 $ 15,830 Less: Tax at 33% $ $ 733 S 1,472 $ 6,214 $ 5,224 Increase in after-tax income $ (445) $ 1,487 S 2,988 $ 12,616 $ 10,606 Add back depreciation $ 3,600 $ 5,280 S 5,040 $ 5,670 $ 5,670 Net change in cash flow (25,000) $ 3,155 $ 6,767 $ 8,028 $ 18,286 $ 16,276 Figure 2 Financial analysis of Project B Initial Expenditures Net cost of new assets $75,000 2021 2022 2023 2024 2025 Additional revenue $ 8,313 $ 16,625 $ 24,938 $ $ 49,875 37,406 2,625 $ 2,625 $ 2,625 $ 2,625 $ S 2,625 Additional operating costs Depreciation $ 1.925 $ 1,925 S 1,925 $ 1,925 s 1.925 Net increase in income $ 3,763 $ 12,075 s 20,388 $ 32,856 S 45,325 $ $ 3,985 S 6.728 $ 10.843 S 14,957 Less: Tax at 33% Increase in after-tax income 1.242 2,521 $ $ 8,090 $ 13,660 $ 22,014 S 30,368 Add back Amortization $ 1,925 $ 1,925 S 1,925 $ 1,925 S 1,925 Net change in cash flow $ 4,446 $ 10,015 S 15,585 $ 23,939 S 32,293 (75,000) Financial analysis of Project C Figure 3 Initial Expenditures 2021 2022 2023 2024 2025 Net cost of new assets 100,000 Additional revenue $ 11,000 $ 22,000 S 33,000 $ 49,500 $ 66,000 Additional operating costs $ 5,000 $ 5,000 $ 5,000 $ 5,000 $ 5,000 Depreciation $ 14,000 $ 20,000 $ 17,500 $ 17,500 $ 17,500 Net increase in income $ (8,000) $ (3,000) $ 10,500 $ 27,000 $ 43,500 Less: Tax at 33% $ $ $ 3,465 $ 8,910 $ 14.355 Increase in after-tax income $ (8,000) $ (3,000) $ 7,035 $ 18,090 $ 29,145 Add back depreciation $ 14,000 $ 20,000 $ 17,500 $ 17,500 $ 17,500 Net change in cash flow $ (100,000) $ 6,000 $ 17,000 $ 24,535 $ 35,590 $ 46,645 Figure 4 Financial analysis of Project D Initial Expenditures 2021 2022 2023 2024 2025 Net cost of new assets $55,000 Additional revenue $ $ 37,500 $ 10,000 $ 8,500 $ 6,500 45,000 3,000 Additional operating costs $ $ 4,000 $ 5,000 $ 5,500 $ 6,000 Depreciation $ 8,000 $ 12,000 $ 11,000 $ 11,000 $ 11,000 Net increase in income $ 34,000 $ 21,500 $ (6,000) $ (8,000) $ (10,500) Less: Tax at 33% $ 11.220 $ 7,095 $ $ $ Increase in after-tax income $ 22,780 $ 14,405 $ (6,000) $ (8,000) $ (10,500) Add back depreciation $ 8,000 $ 12,000 $ 11,000 $ 11,000 $ 11,000 Net change in cash flow $ (55,000) $ 30,780 $ 26,405 $ 5,000 $ 3,000 $ 500 Figure 5* Accounting information 2021 forecast 2020 2019 COGS ?? ?? ?? Cash $ 52,663 $ 87,000 $ 74,440 Depreciation Expense $ 10,000 $ 10,000 $ 10,000 Interest Expense $ $ $ SG&A Expenses $ 71,663 $ 68,250 $ 65,000 Accounts Payable $ $ $ Net Fixed Assets $ 105,000 $ 90,000 $ 100,000 Sales $ 275,625 $ 262,500 $ 250,000 Accounts Receivable $ 55,487 $ 37,500 42,940 $ 52,500 $ Inventory $ 70,903 $ 50,000 Common Stock Par @ $1 $ 10,000 $ 10,000 $ 10,000 Add'l Paid in Capital $ 217,200 $ 217,200 $ 217,200 $ 25,300 Preferred Equity par @ 100 Retained earnings $ 25,300 $ 25,300 $ ?? ??. ?? Long term Debt - $ $ $ 2021 2022 2023 2024 2025 $ 3,655 $ 8,000 S 10,000 $ Figure 1 Financial analysis of Project A Initial Expenditures Net cost of new fixed assets $25,000 Additional revenue Additional operating costs Depreciation Net increase in income 25,000 $ 22,000 $ 500 $ 500 $ 500 $ 500 $ 500 $ 3.600 $ 5.280 S 5,040 $ 5.670 $ 5.670 $ (445) $ 2,220 S 4,460 18,830 $ 15,830 Less: Tax at 33% $ $ 733 S 1,472 $ 6,214 $ 5,224 Increase in after-tax income $ (445) $ 1,487 S 2,988 $ 12,616 $ 10,606 Add back depreciation $ 3,600 $ 5,280 S 5,040 $ 5,670 $ 5,670 Net change in cash flow (25,000) $ 3,155 $ 6,767 $ 8,028 $ 18,286 $ 16,276 Figure 2 Financial analysis of Project B Initial Expenditures Net cost of new assets $75,000 2021 2022 2023 2024 2025 Additional revenue $ 8,313 $ 16,625 $ 24,938 $ $ 49,875 37,406 2,625 $ 2,625 $ 2,625 $ 2,625 $ S 2,625 Additional operating costs Depreciation $ 1.925 $ 1,925 S 1,925 $ 1,925 s 1.925 Net increase in income $ 3,763 $ 12,075 s 20,388 $ 32,856 S 45,325 $ $ 3,985 S 6.728 $ 10.843 S 14,957 Less: Tax at 33% Increase in after-tax income 1.242 2,521 $ $ 8,090 $ 13,660 $ 22,014 S 30,368 Add back Amortization $ 1,925 $ 1,925 S 1,925 $ 1,925 S 1,925 Net change in cash flow $ 4,446 $ 10,015 S 15,585 $ 23,939 S 32,293 (75,000) Financial analysis of Project C Figure 3 Initial Expenditures 2021 2022 2023 2024 2025 Net cost of new assets 100,000 Additional revenue $ 11,000 $ 22,000 S 33,000 $ 49,500 $ 66,000 Additional operating costs $ 5,000 $ 5,000 $ 5,000 $ 5,000 $ 5,000 Depreciation $ 14,000 $ 20,000 $ 17,500 $ 17,500 $ 17,500 Net increase in income $ (8,000) $ (3,000) $ 10,500 $ 27,000 $ 43,500 Less: Tax at 33% $ $ $ 3,465 $ 8,910 $ 14.355 Increase in after-tax income $ (8,000) $ (3,000) $ 7,035 $ 18,090 $ 29,145 Add back depreciation $ 14,000 $ 20,000 $ 17,500 $ 17,500 $ 17,500 Net change in cash flow $ (100,000) $ 6,000 $ 17,000 $ 24,535 $ 35,590 $ 46,645 Figure 4 Financial analysis of Project D Initial Expenditures 2021 2022 2023 2024 2025 Net cost of new assets $55,000 Additional revenue $ $ 37,500 $ 10,000 $ 8,500 $ 6,500 45,000 3,000 Additional operating costs $ $ 4,000 $ 5,000 $ 5,500 $ 6,000 Depreciation $ 8,000 $ 12,000 $ 11,000 $ 11,000 $ 11,000 Net increase in income $ 34,000 $ 21,500 $ (6,000) $ (8,000) $ (10,500) Less: Tax at 33% $ 11.220 $ 7,095 $ $ $ Increase in after-tax income $ 22,780 $ 14,405 $ (6,000) $ (8,000) $ (10,500) Add back depreciation $ 8,000 $ 12,000 $ 11,000 $ 11,000 $ 11,000 Net change in cash flow $ (55,000) $ 30,780 $ 26,405 $ 5,000 $ 3,000 $ 500 Figure 5* Accounting information 2021 forecast 2020 2019 COGS ?? ?? ?? Cash $ 52,663 $ 87,000 $ 74,440 Depreciation Expense $ 10,000 $ 10,000 $ 10,000 Interest Expense $ $ $ SG&A Expenses $ 71,663 $ 68,250 $ 65,000 Accounts Payable $ $ $ Net Fixed Assets $ 105,000 $ 90,000 $ 100,000 Sales $ 275,625 $ 262,500 $ 250,000 Accounts Receivable $ 55,487 $ 37,500 42,940 $ 52,500 $ Inventory $ 70,903 $ 50,000 Common Stock Par @ $1 $ 10,000 $ 10,000 $ 10,000 Add'l Paid in Capital $ 217,200 $ 217,200 $ 217,200 $ 25,300 Preferred Equity par @ 100 Retained earnings $ 25,300 $ 25,300 $ ?? ??. ?? Long term Debt - $ $ $