[Year]

Date:March 5, 2020Professor:Anne Burpee, CPA CMA

Name: Adrian Villafuerte_____________________

Name:RetnoIshadi_________________________

Name: AhmadMujatabaRasooli_______________

Name: Ahmad Murtaza______________________

Name: Feng Lu_____________________________

Student No. 301052567______________________

Student No. 300924913______________________

Student No. 300962425______________________

Student No. 300962331______________________

Student No. 300678641______________________

Instructions:

For thissecondcase study,your group willcompleteacaseontheLookkinGood Company.You willutilizeandapply the cumulative finance knowledge from Chapters14 - Capital Markets, 15-Investment Underwriting,16-Long Debt and Lease Financing,17-Common and Preferred Stock Financing, and18- DividendPolicyand Retained Earnings.

The report is to be word processed (type written) with no page limit; use Excel tofacilitate your computation. Be sure toprovide comprehensive responses to all the questions.

Doincludeandshowdetailedcalculationsas this can give you partial marks even if the answer is incorrect (demonstrate an understanding of concepts).

Hand in a hard copy of the report on the due dateANDan electronic copy ineCentennialdrop box.

I expect equal contributionand quality workby all team members.

The Case Study isweighted as 7.5 points towardsyour total coursegrade.

The Case Study scoring is on 40 points.

TheLookkinGood Company(LGC)was founded 3 years ago byJinmei, a grade 9 student inMerrickville, Ontario.Her company manufactures environmentally friendly cosmetics and has seen some amazing growthover the lastthreeyears.Jinmeiis a new CEO and is still learning the ropes and is looking to you for advice.

Looking Good Company

Income Statementandother information

Year 3

Year 10

Revenue

2,000,000

Expenses

1,000,000

1,000,000

Tax (35%)

350,000

Net profit

650,000

8,000,000

Equipment cost

50,000

Cost to borrow

12%

CCA

25%

Net cash flow

2,400,000

Stock price

$64.00

Jinmeiand herbrothersplit ownership andowna total of1,000,000 common shares.

Jinmeiis so excited that LGC is doing so well in Year 3.Revenues have sky-rocketed and she has had to hireall the students at her school.Sheisconsidering whether she shouldborrow funds andpurchaseproductionequipment to manufacture the cosmeticsor leaseunder anoperating leasearrangement.If LGC purchases the equipment, it will cost$50,000.LGC can borrow funds from thebank for 4 years at 12 percent interest.The equipment will qualify for a25 percent CCA.Assume a tax rate of35percent.

The other alternative is to sign two operating leases, one with payments of $2,600 for the first two years and the other with payments of $4,600 for the last two years.In your analysis, note all round values to the nearest dollar.The leases should be treated as operating leases.(Questions 1 to 9).

In the end,Jinmeidecides to not acquire any new equipment.An investment dealer, ABC Securities,has convinced her that going public isbestwayto raise fundsfor her production equipment purchase and company growth plans.

The new public issueis anticipated to occur at the beginning of Year 4 andwillrepresentabout2,000,000 shares.The new shares will be priced to the public at $15.00per common share, with a 4% spread on the offering price.There will also be $150,000 in out-of-pocket costs to the corporation.(Note -assume shares are issuedon January 1).(Questions 10 to 14).

In Year 10, LGC has finally arrived at a point where it has excess cash flows of $2.4 million.Jinmeiwishes to consider paying a cash dividend of $1.20 per share to her shareholders.LGC shares were trading at $64.00.However, her brother,Jinhou, was uncertain whether paying the cash dividend was the way to go, and before a recommendation was to the Board of Directors, heasked you to doa few calculations(Questions 15 to 20).

1.Jinmeiis uncertain what it means to capitalize lease payments.Please explain.

To capitalize lease payments means to recognize both amortization and interest on the lease. In this instance, the asset is considered to be a purchase of an asset. With regards to a capital lease asset, it is amortized over the life of the lease and not the life of the asset itself. A capital lease liability on the other hand, is amortized via an interest expense on the remaining balance of the lease liability.

2.She would also like to understand in a lease vs buy decision, why is the discount rate the after-tax cost of debt.Please explain.

In a lease vs. buy decision, the discount rate is the after-tax cost of debt. This is the discount

rate that is usedrather than the cost of capital that is commonly used in the majority of capital budgeting decisions.The after-tax cost of debt is used because it is a lower discount rate, thus representing a greater certainty in future cash flows.

3.Compute the after-tax cost of the lease for the four years.

4.Compute the annual payment of the loan.

5.Compute the amortization of the loan (disregard a small difference from a zero balance at the end of the loan.It is due to rounding).

6.Determine the cash flow effect of the CCA.

7.Determine the after-tax cost of the borrow-purchase alternative.

8.Compute the present value of the after-tax cost of the two alternatives.

9.If the objective is to minimize the present value of after-tax costs, which alternative should be selected.

10.Compute the net proceedsof the stock issuetoLookkinGood Company.

Spread= 4 %

$15 x (1-4%) =$14.40 net price

$14.40 net price x 2,000,000 new shares =$ 288,00,000 (proceeds before out-of-pocket costs)

$ 288,00,000 - $150,000 out of pocket cost= $28,650,000 (net proceeds)

thenet proceedsof the stock issueis$28,650,000

11.Calculate EPS before the stock issue.

After tax earning is $650,000common shares before share issue is 1,000,000 shares

EPS before the stock issue= After tax earning/ common shares before share issue=$650,000/1,000,000=$0.65

EPS before the stock issue is $ 0.65/share.

12.Calculate EPS after the stock issue.

EPS after the stock issue= After tax earning/ common shares after share issue =$650,000/ (1,000,000+ 2,000,000) =$0.22

EPS after the stock issue is $0.22/share.

13.Calculate the rate of return that must be earned on net proceeds to the corporation so that there is no dilution in EPS during the year of going public.

There are now 3,000,000 shares, to maintain earning of $0.65/ share, total earning must be $1,950,000 (3,000,000 x $ 0.65). This would imply an increase in earning of $ 1,300,000 ($1,950,000 - $650,000)

Incremental earnings/ Net proceeds = $1,300,000/$28,650,000= 4.54%

4.54% must be earned on the net proceeds to produce EPS of $0.65

14.Determine what rate of return must be earned in proceeds so that there will be a 4% increase in EPS during the year of going public.

$0.65x1.04=$0.68 (4% increase in EPS)

Total earning=$0.68 x 3,000,000 shares = $2,040,000

Incremental earning = $2,040,000-$650000=$1,390,000

Incremental earning/ Net proceeds =$1,390,000/$28,650,000=4.85%

4.85% would have to be earned to produce EPS of $0.65

15.What is LGC's PE ratio?

LGCs PE ratio is 8x.

16.If LGC paid a cash dividend, what would beits dividend yield and dividend payout per share?

If LGC paid a cash dividend the dividend yield and dividend payout per share would be 1.88% and 1.2x respectively.

17.If a shareholder held 100 shares and received the cash dividend, what would be the total value of the shareholder's portfolio?

If a shareholder held 100 shares and received the cash dividend, the total value of the shareholder's portfolio would be $1,006,280.

18.Assume that instead of paying out the cash dividend, the firm used $2.4 millionof excess funds to purchase shares at $65.20, slightly over the current market price.How many shares could be repurchased?(round to the nearest share).

Based on this assumption, LGC can repurchase a total of 36,810 shares.

19.What would be the new EPS under the sharerepurchase alternative?

20.What is the payout ratio under the cash dividend alternative?