Assume a company with a single product. Listed below is some information, that you can use to recreate its income statement. You can also use this information to calculate the cash flows for the capital budgeting exercise for a period of 5 years. Furthermore, you can use this information to create a forecasted income statement and to create a cash budget as we have done in class.
You can use linear depreciation to calculate the depreciation expense.
To calculate interest payments, please use the number for capital expense and the leverage ratio.
To calculate equity, you can use the number for capital expense and correct for the leverage ratio (you can also deduct debt from capital expense).
Some points:
briefly discuss your answers.
The written text in your answers should not be longer than one written page (you can however include as many graphs as you like, even if these would get you over the 1 page limit). Quality answers are better than long.
Support your arguments with numbers, where applicable.
When you are done, you can upload your answers as a Word Document or as a pdf file.
Please download the following Excel file with the information to complete the case study:
Using the information above, please answer the following questions:
Capital Budgeting
1) Create a sensitivity analysis, a scenario analysis or a Monte Carlo Simulation for the capital budgeting project. Plot the results. What do you notice?
2) Is wealth being generated by the company with this project over a period of 5 years (Hint: calculate the NPV using equal cash flows for years 1 – 4 (same sales and costs for 4 years) and adjusting the final cash flow with the change in NOWC)?
3)How would you improve the outcome, looking at either scenario analysis or sensitivity analysis (Hint: changing the most sensitive driver only a little bit will still have a big impact).
4) How does changing the weighted average cost of capital influence results? Does the company have any control over its WACC?
Income Statement
5) Create a forecast based on the current income statement under the assumption, that next years sales will change, that management is able to reduce fixed costs and that the company is able to reduce its asset base. What would be the effect on its ROE?
6) How would ROE equity change if the company were to employ more financial leverage. Is this always wise? What else do you expect would change if the company increase its ROE?
Cash Budget
7) Create an intra-year cash budget with the information above. Does the company need to borrow funds throughout the year? What happens to the cash budget if the company decreases its DSO, e.g. improve its cash collection proces?
8) Solely looking at the cash budget, does the company have enough cash in your opinion to pay a dividend in July? Please briefly explain your answer.
General Questions
9) What could the company do to reduce variability in results (Hint: for example, think about operational leverage)?
10) What would be a disadvantage if sales were denominated in USD, but costs were denominated in Japanese Yen?
