28 Jun You are the CFO of Floor Tile Incorporated. There are two investment options your management team has asked you to get Board approval on. The first is a new manufacturing plant in Indiana to service the local construction industry. The second is a new product-line expansion for environmentally conscious consumers when they build or remodel their home. Below are the cash flow estimates for both projects along with some notes on each.
| New Plant | ||||||||||||
| The new plant will cost $15 million to build. The plant will lose money the first year as it ramps up which can be seen below | ||||||||||||
| in the cash flow estimates. The company management estimates that the plant will continue to produce product for years to | ||||||||||||
| come and have indicated that the earning potential of the plant will be worth $10 million at the end of year five. Please take | ||||||||||||
| this into consideration when you consider the value of the plant. Floor Tile Inc. has a weighted Average Cost of Capital of | ||||||||||||
| 11%. The CFO believes this investment is consistent with the company’s existing business model and has the same risk | ||||||||||||
| profile. | ||||||||||||
| New Plant in Indiana | ||||||||||||
| (dollars in millions) | ||||||||||||
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | ||||||||
| Free Cash Flow | ($1.0) | $3.0 | $4.0 | $5.5 | $17.0 | |||||||
| New Product Line | ||||||||||||
| The new product line will cost $25 million up front to launch. The $25 million will include the price of a new plant for | ||||||||||||
| manufacturing as well as the equipment. Because this new environmentally friendly tile is much more expensive the | ||||||||||||
| company feels they will need a new sales force and it will take a few years before the product is cash flow positive due to | ||||||||||||
| the ramp up of sales. It is a different customer base and the CFO believes consumers will turn back to lower cost product at | ||||||||||||
| the expense of the environment so he is certain it is more risky than the company’s traditional business. He has used data | ||||||||||||
| from companies with environmentally focused products to determine this project’s Weighted Average Cost of Capital is | ||||||||||||
| 13%. It too will have a terminal value and the management team estimates that at the end of 5 years the new product line | ||||||||||||
| will be worth $22 million. | ||||||||||||
| New Environmentally Friendly Tile | ||||||||||||
| (dollars in millions) | ||||||||||||
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | ||||||||
| Free Cash Flow | ($3.0) | ($1.0) | $5.0 | $8.0 | $36.0 | |||||||
| Should the CFO propose both projects to the board. Why or why not? How did you determine this? Show your work. | ||||||||||||
| (10) | Project 1 | |||||||||||
| (10) | Project 2 | |||||||||||
| (5) | What discount rate did you use for the New Product line? Why? | |||||||||||
| (5) | If the CFO chose to use the companies Cost of Capital to assess the new product line would he have made a different decision | |||||||||||
| about proposing the project? | ||||||||||||
| Q2 | The current 10 year government bond is trading at 2.0%. The beta of the market is 1.0. The long term equity risk premium is 7%. | |||||||||||
| (5) | Draw the Security Market Line (SML). Label both Axes. | |||||||||||
| (10) | Now show where a stock would fall on that line if it had a beta of 1.4? What would its expected return be? | |||||||||||
| SML | ||||||||||||
| Q3 | You are trying to decide what the WACC of a Company in the mining industry should be. You have determined | |||||||||||
| (15) | from its peer companies that the unlevered beta for the industry is 1.25. The 10 year government bond is trading | |||||||||||
| at 2.0%. The Company’s debt currently has an interest rate of 7.0% and is trading at par. The Company’s tax rate | ||||||||||||
| is 37%. The equity risk premium is 7%. The Company currently has a market value of $700 million. It has $114.5` | ||||||||||||
| million in net debt outstanding (see statements below). This is the capital structure the company expects to have | ||||||||||||
| well into the future. What is the Company’s cost of capital? | ||||||||||||
| Q4 | Use the data from Question 3 plus the data below. | |||||||||||
| (10) | What is the Company’s 2010 EBITDA Multiple? | |||||||||||
| (10) | What is the Company’s 2010 P/E multiple? | |||||||||||
| (10) | What is the Company’s Return on Capital? | |||||||||||
| (10) | What is the Company’s 2010 DSO? | |||||||||||
| days | ||||||||||||
| Mining Co. Inc. – Income Statement | 2009 | 2010 | ||||||||||
| Revenue | $460.0 | $700.0 | ||||||||||
| Cost of Goods Sols | 165.6 | 238.0 | ||||||||||
| Gross Profit | 294.4 | 462.0 | ||||||||||
| Sell., Gen. and Admin. Exp. | 207.0 | 301.7 | ||||||||||
| Operating Income | $87.4 | $160.3 | ||||||||||
| Interest Expense | 2.0 | 6.0 | ||||||||||
| Pre-Tax Income | 85.4 | 154.3 | ||||||||||
| Taxes | 29.9 | 54.0 | ||||||||||
| Net Income | $55.5 | $100.3 | ||||||||||
| Balance Sheet | 2009 | 2010 | ||||||||||
| Cash | $75.0 | $35.5 | ||||||||||
| Accounts Receivable | 92.0 | 210.0 | ||||||||||
| Inventory | 69.0 | 126.0 | ||||||||||
| Total Current Assets | $236.0 | $371.5 | ||||||||||
| Property Plant and Equipment | 184.0 | 280.0 | ||||||||||
| Total Assets | $420.0 | $651.5 | ||||||||||
| Accounts Payable | 59.8 | 91.0 | ||||||||||
| Total Current Liabilities | $59.8 | $91.0 | ||||||||||
| Debt | 50.0 | 150.0 | ||||||||||
| Total Liabilities | $109.8 | $241.0 | ||||||||||
| Shareholders’ Equity | 310.2 | 410.5 | ||||||||||
| Total Liabilities & Shareholders’ Equity | $420.0 | $651.5 | ||||||||||
| Statement of Cash Flow | 2009 | 2010 | ||||||||||
| Cash Flow from Operation | ||||||||||||
| Net Income | $55.5 | $100.3 | ||||||||||
| Change in Working Capital | (143.8) | |||||||||||
| Depreciation | 26.3 | |||||||||||
| Free Cash Flow from Operations | ($17.2) | |||||||||||
| Cash Flow from Investing | ||||||||||||
| Additions to Property Plant and Equipment | (122.3) | |||||||||||
| Free Cash Flow from Investing | ($122.3) | |||||||||||
| Cash Flow from Financing | ||||||||||||
| Issuance/(Paydown) of Debt | 100.0 | |||||||||||
| Issuance/(Repurchase) of Equity | 0.0 | |||||||||||
| Cash Flow from Financing Activities | $100.0 | |||||||||||
| Cash Flow Generated/(Used) During the Year | ($39.5) | |||||||||||
| Beginning of Year Cash | 75.0 | |||||||||||
| End of Year Cash | 35.5 | |||||||||||
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