财务管理Case1，含答案 - 财务管理Case1，含答案 PDF

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财务管理Case1，含答案...

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Case1 Case study----Bethesda mining company Bethesda Mining is a midsized coal mining company with 20 mines located in Ohio, Pennsylvania, West Virginia, and Kentucky. The company operates deep mines as well as strip mines. Most of the coal mined is sold under contract, with excess production sold on the spot market. The coal mining industry, especially high-sulfur coal operations such as Bethesda, has been hard-hit by environmental regulations. Recently, however, a combination of increased demand for coal and new pollution reduction technologies has led to an improved market demand for high-sulfur coal. Bethesda has just been approached by Mid-Ohio Electric company with a request to supply coal for its electric generators for the next four years. Bethesda Mining does not have enough excess capacity at its existing mines to guarantee the contract. The company is considering opening a strip mine in Ohio on 5,000 acres of land purchased 10 years ago for $6 million. Based on a recent appraisal, the company feels it could receive $7 million on an aftertax basis if it sold the land today. Strip mining is a process where the layers of topsoil above a coal vein are removed and the exposed coal is removed. Some time ago, the company would simply remove the coal and leave the land in an unusable condition. Changes in mining regulations now force a company to reclaim the land; that is, when the mining is completed, the land must be restored to near its original condition. The land can then be used for other purposes. Because it is currently operation at full capacity, Bethesda will need to purchase additional necessary equipment, which will cost $85 million. The equipment will be depreciated on a seven-year MACRS schedule. The contract runs for only four years. At that time the coal from the site will be entirely mined. The company feels that the equipment can be sold for 60 percent of its initial purchase price in four years. However, Bethesda plans to open another strip mine at that time and use the equipment at the new mine. The contract calls for the delivery of 500,000 tons of coal per year at a price of $95 per ton. Bethesda mining feels that coal production will be 620,000 tons, 680,000 tons,730,000 tons, and 590,000 tons, respectively, over the next four years. The excess production will be sold in the spot market at an average of $90 per ton. Variable costs amount to $31 per ton, and fixed costs are $4,300,000 per year. The mine will require a net working capital investment of 5 percent of sales. The NWC will be built up in the year prior to the sales.

Bethesda will be responsible for reclaiming the land at termination of the mining. This will occur in year 5. the company uses an outside company for reclamation of all the company’s strip mines. It is estimated the cost of reclamation will be $2.8 million. After the land is reclaimed, the company plans to donate the land to the state for use as a public park and recreation area. This will occur in year 6 and result in a charitable expense deduction of $7.5 1

million. Bethesda faces a 38 percent tax rate and has a 12 percent required return on new strip mine projects. Assume that a loss in any year will result in a tax credit.

Requirement : You have been approached by the president of the company with a request to analyze the project. Calculate the payback period, profitability index, average accounting return, net present value, internal rate of return, and modified internal rate of return for the new strip mine. Should Bethesda mining take the contract and open the mine?

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Answers of Case 1 To analyze this project, we must calculate the incremental cash flows generated by the project. Since net working capital is built up ahead of sales, the initial cash flow depends in part on this cash outflow. So, we will begin by calculating sales. Each year, the company will sell 500,000 tons under contract, and the rest on the spot market. The total sales revenue is the price per ton under contract times 500,000 tons, plus the spot market sales times the spot market price. The sales per year will be: Year 1

Year 2

Year 4

$47,500,00

$47,500,00

$47,500,00

0

0

0

$47,500,000

10,800,000

16,200,000

20,700,000

8,100,000

$58,300,00

$63,700,00

$68,200,00

0

0

0

Contract Spot

Year 3

Total

$55,600,000

The current aftertax value of the land is an opportunity cost. The initial outlay for net working capital is the percentage required net working capital times Year 1 sales, or: Initial net working capital = .05($22,400,000) = $1,120,000 So, the cash flow today is:

– $85,000,00 0

Equipment Land

–7,000,000

NWC

–2,915,000 – $94,915,00 0

Total

Now we can calculate the OCF each year. The OCF is:

Sales

Year

Year

Year

Year

Year

1

2

3

4

5

$58,300,000 $63,700,000 $68,200,000 $55,600,000

VC 19,220,000

21,080,000

22,630,000

18,290,000

4,300,000

4,300,000

4,300,000

4,300,000

Dep. 12,155,000

20,825,000

14,875,000

10,625,000

FC

Year 6

3

$2,800,000 $7,500,000

– EBT $22,625,000 $17,495,000 $26,395,000 $22,385,000 –$2,800,000 $7,500,000 Tax

8,597,500

6,648,100

10,030,100

8,506,300

1,064,000 2,850,000

– NI $14,027,500 $10,846,900 $16,364,900 $13,878,700 –$1,736,000 $4,650,000 +Dep. 12,155,000

20,825,000

14,875,000

10,625,000

0

0 –

OCF

$26,182,500 $31,671,900 $31,239,900 $24,503,700 –$1,736,000 $4,650,000

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Years 5 and 6 are of particular interest. Year 5 has an expense of $2.8 million to reclaim the land, and it is the only expense for the year. Taxes that year are a credit, an assumption given in the case. In Year 6, the charitable donation of the land is an expense, again resulting in a tax credit. The land does have an opportunity cost, but no information on the aftertax salvage value of the land is provided. The implicit assumption in this calculation is that the aftertax salvage value of the land in Year 6 is equal to the $7.5 million charitable expense.

Next, we need to calculate the net working capital cash flow each year. NWC is 5 percent of next year’s sales, so the NWC requirement each year is:

Year 1

Year 2

Year 3

Year 4

$2,915,000

$3,185,000

$3,410,000

$2,780,000

3,185,000

3,410,000

2,780,000

–$270,000

–$225,000

$630,000

Beg. NWC End NWC NWC CF

$2,780,000

The last cash flow we need to account for is the salvage value. The fact that the company is keeping the equipment for another project is irrelevant. The aftertax salvage value of the equipment should be used as the cost of equipment for the new project. In other words, the equipment could be sold after this project. Keeping the equipment is an opportunity cost associated with that project. The book value of the equipment is the original cost, minus the accumulated depreciation, or:

Book value of equipment = $85,000,000 – 12,155,000 – 20,825,000 – 14,875,000 – 10,625,000 Book value of equipment = $26,520,000

Since the market value of the equipment is $51 million, the equipment is sold at a gain to book value, so the sale will incur the taxes of:

Taxes on sale of equipment = ($26,520,000 – 51,000,000)(.38) = –$9,302,400

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And the aftertax salvage value of the equipment is:

Aftertax salvage value = $51,000,000 – 9,302,400 Aftertax salvage value = $41,697,600

So, the net cash flows each year, including the operating cash flow, net working capital, and aftertax salvage value, are:

Time

Cash flow

0

–$94,915,000

1

25,912,500

2

31,446,900

3

31,869,900

4

68,981,300

5

–1,736,000

6

–4,650,000

6

So, the capital budgeting analysis for the project is:

Payback period = 3 + $5,685,700/$68,981,300 Payback period = 3.08 years

Profitability index = ($25,912,500/1.12 + $31,446,900/1.122 + $31,869,900/1.123 + $68,981,300/1.124 – $1,736,000/1.125 – $4,650,000/1.126) / $94,915,000 Profitability index = 1.174

To calculate the AAR, we divide the average net income by the average book value. Since the cash flows from the project extend for two years past the end of mining operation, we will include an average book value of zero for the last two years. So, the AAR is:

AAR = [($14,027,500 + 10,846,900 + 16,364,900 + 13,878,000 – 1,736,000 – 4,650,000) / 6] / [(85,000,000 + 72,845,000 + 52,020,000 + 37,145,000 + 26,520,000 + 0) / 7] AAR = .1485 or 14.85%

The equation for IRR is:

0 = –$94,915,000 + $25,912,500/(1 + IRR) + $31,446,900/(1 + IRR)2 + $31,869,900/(1 + IRR)3 + $68,981,300/(1 + IRR)4 – $1,736,000/(1 + IRR)5 – $4,650,000/(1 + IRR)6

Using a spreadsheet or financial calculator, the IRRs for the project are:

IRR = 19.01%, –74.64%

MIRR = 12.94% NPV = –$94,915,000 + $25,912,500/1.12 + $31,446,900/1.122 + $31,869,900/1.123 + $68,981,300/1.124 – $1,736,000/1.125 – $4,650,000/1.126 NPV = $16,472,777.67

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In the final analysis, the company should accept the project since the NPV is positive.

Case 2 Project Evaluation This is a comprehensive project evaluation bringing together much of what you have learned in this and previous chapters. Suppose you have been hired as a financial consultant to PEL, a large, publicly traded firm that is the market share leader in radar detection systems(RDSs). The company is looking at setting up a manufacturing plant overseas to produce a new line of RDSs. This will be a five-year project. The company bought some land three years ago for ￠4 million in anticipation of using it as a toxic dump site for waste chemicals , but it built a piping system to safely discard the chemicals instead. If the company sold the land today, it would receive ￠6.5 million after tax. In five years, the land can be sold for ￠4.5 million after tax and reclamation costs. The company wants to built its new manufacturing plant on this land; the plant will cost ￠15 million to build. The following market data on PEL’s securities are current. Debt:

15000 7% coupon bonds outstanding,15 years to maturity, selling for 92% of par, the bonds have a ￠1000 par value each and make semiannual payments

Common stock: Preferred stock

300,000 shares outstanding, selling for ￠75 pre share, the beta is 1.3 20,000 shares of 5% preferred stock outstanding, selling for ￠72 pre share

Market:

8% expected market risk premium,5% risk-free rate

PEL’s tax rate is 35%. The project requires ￠900,000 in initial net working capital investment to become operational. a)

Calculating the project’s initial time 0 cash flow, taking into accounts all side effects;

b)

The new RDS project is somewhat riskier than the typical project for PEL, primarily because the plant is being located overseas. Management has told you to use an adjustment factor of +2% to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating PEL’s project.

c)

The manufacturing plant has an 8-year tax life, and PEL uses straight-line depreciation. At the end of the project (ie: at the end of year 5), the plant can be scrapped for ￠5 million. What is the aftertax salvage value of this manufacturing plant?

d)

The company will incure ￠400,000 in annual fixed cost. The plant is to manufacturing 12,000 RDSs per year and sell them at ￠10,000 per machine; the variable production costs are ￠9,000 per RDSs. What is the annual operating cash flow from this project?

e)

f)

PEL’s comptroller is primarily interested in the impact of PEL’s investments on the bottom line of reported accounting statements. What will you tell her is the accounting break-even quantity of RDSs sold for this project? Finally, PEL’s president wants you to throw all your calculations, assumptions, and everything else into the report for the chief financial officer; all he wants to know is the 8

RDS project’s internal rate of return, IRR, and net present value, NPV. What will you report?

Answers of Case 2 The $4 million cost of the land 3 years ago is a sunk cost and irrelevant; the $6.5 million appraised value of the land is an opportunity cost and is relevant. The relevant market value capitalization weights are: MVD = 15,000($1,000)(0.92) = $13,800,000 MVE = 300,000($75) = $22,500,000 MVP = 20,000($72) = $1,440,000 The total market value of the company is: V = $13,800,000 + 22,500,000 + 1,440,000 = $37,740,000 Next we need to find the cost of funds. We have the information available to calculate the cost of equity using the CAPM, so: RE = .05 + 1.3(.08) = .1540 or 15.40% The cost of debt is the YTM of the company’s outstanding bonds, so: P0 = $920 = $35(PVIFAR%,30) + $1,000(PVIFR%,30) R = 3.96% YTM = 3.96% × 2 = 7.92% And the aftertax cost of debt is: RD = (1 – .35)(.0792) = .0515 or 5.15% The cost of preferred stock is: RP = $5/$72 = .0694 or 6.94%

a.

The initial cost to the company will be the opportunity cost of the land, the cost of the plant, and the net working capital cash flow, so: CF0 = –$6,500,000 – 15,000,000 – 900,000 = –$22,400,000 b.

To find the required return on this project, we first need to calculate the WACC for the company. The company’s WACC is: WACC = [($22.5/$37.74)(.1540) + ($1.44/$37.74)(.0694) + ($13.8/$37.74)(.0515)] = . 1133

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The company wants to use the subjective approach to this project because it is located overseas. The adjustment factor is 2 percent, so the required return on this project is: Project required return = .1133 + .02 = .1333 c.

The annual depreciation for the equipment will be: $15,000,000/8 = $1,875,000 So, the book value of the equipment at the end of five years will be: BV5 = $15,000,000 – 5($1,875,000) = $5,625,000 So, the aftertax salvage value will be: Aftertax salvage value = $5,000,000 + .35($5,625,000 – 5,000,000) = $5,218,750

d.

Using the tax shield approach, the OCF for this project is: OCF = [(P – v)Q – FC](1 – t) + tCD OCF = [($10,000 – 9,000)(12,000) – 400,000](1 – .35) + .35($15M/8) = $8,196,250

e.

The accounting breakeven sales figure for this project is: QA = (FC + D)/(P – v) = ($400,000 + 1,875,000)/($10,000 – 9,000) = 2,275 units

f. We have calculated all cash flows of the project. We just need to make sure that in Year 5 we add back the aftertax salvage value, the recovery of the initial NWC, and the aftertax value of the land. The cash flows for the project are: Year 0 1

Flow Cash –$22,400,000 8,196,250

2 3

8,196,250 8,196,250

4

8,196,250

5

18,815,000

Using the required return of 13.33 percent, the NPV of the project is: NPV = –$22,400,000 + $8,196,250(PVIFA13.33%,4) + $18,815,000/1.13335 NPV = $11,878,610.78

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And the IRR is: NPV = 0 = –$22,400,000 + $8,196,250(PVIFAIRR%,4) + $18,815,000/(1 + IRR)5 IRR = 30.87%

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