Assume that as a financial management trainee at Extra Tech Company – a computer service firm - you have just completed the following tasks:
· Analysis of the financial statements.
· Analysis of capital investment projects
CEO of your company is considering investing in one of the four projects offered to your company. With no background in financial theory, he is not sure which project should be selected. In addition, he is not very much aware about the financial health of the company. He is confident about your analytical skills and want you to analyze company’s financial statements and recommend the best project for the investment.
During the meeting, your CEO has provided you the financial statements and shared the details of the following four projects, all of which are considered to be equally risky with 12% minimum acceptable rate of return. The company calculated depreciation and the company’s tax rate is 35%. Previously company borrowed long term debt and paying $5000 interest expense each year.
Proposal –A:
This proposal is to buy machine. Machine is six years old and was considered a good buy at $400,000. In return, the machine would bring the following revenue and operating costs.
|
YR-0
|
YR-1
|
YR-2
|
YR-3
|
YR-4
|
YR-5
|
Initial investment
|
(400,000)
|
|
|
|
|
|
Revenue
|
|
44,000
|
78,000
|
112,300
|
225,000
|
168,750
|
Operating costs
|
|
11,250
|
12,000
|
12,500
|
13,000
|
14,000
|
Depreciation Expense
|
|
60,000
|
60,000
|
60,000
|
60,000
|
60,000
|
Proposal –B:
This proposal is to buy copy machines. The new business was expected to bring the following revenue and operating costs.
|
YR-0
|
YR-1
|
YR-2
|
YR-3
|
YR-4
|
YR-5
|
Initial investment
|
(600,000)
|
|
|
|
|
|
Revenue
|
|
87,500
|
175,000
|
262,500
|
393,750
|
525,000
|
operating costs
|
|
26,000
|
27,000
|
29,000
|
30,000
|
32,000
|
Depreciation Expense
|
|
110,000
|
110,000
|
110,000
|
110,000
|
110,000
|
Proposal—C:
This proposal is to buy a Jet. The Jet was expensive and, counting additional training and licensing requirements. However, it would give the company access to a wider market as well.
Following are key financial figures:
|
YR-0
|
YR-1
|
YR-2
|
YR-3
|
YR-4
|
YR-5
|
Initial investment
|
(800,000)
|
|
|
|
|
|
Revenue
|
|
200,000
|
300,000
|
400,000
|
450,000
|
500,000
|
Operating costs
|
|
60,000
|
85,000
|
95,000
|
98,000
|
105,000
|
Depreciation Expense
|
|
140,000
|
140,000
|
140,000
|
140,000
|
140,000
|
Proposal – D:
This proposal is to begin operating a fleet of trucks. Ten trucks could be bought for only $61,000 each, and the additional business would bring above $700,000 in new sales in the first two years alone. Following are key financial figures
|
YR-0
|
YR-1
|
YR-2
|
YR-3
|
YR-4
|
YR-5
|
Initial investment
|
(610,000)
|
|
|
|
|
|
Revenue
|
|
382,500
|
325,125
|
89,250
|
76,500
|
51,000
|
Operating costs
|
|
31,000
|
31,000
|
31,000
|
31,000
|
31,000
|
Depreciation Expense
|
|
102,000
|
102,000
|
102,000
|
102,000
|
102,000
|
CEO has particularly discussed his worries/ concerns of the recent economic conditions and his speculation is that operating cost might increase by 8% than expected and revenue might decrease by 5% than the expected!
You are planning to use
internal rate of return, and
net present value
evaluation methods.
You are facing one constraint that there is no outside financing be used this year. CEO is against a stock issue for fear of diluting earnings and his control over the firm. As a result, the size of the capital budgets this year is limited to $800,000, which meant that ONLY ONE of the four projects under consideration could be chosen. You are not too happy about the situation but you have to concentrate on selecting the best of the four.
Do not forget that selection of the project also depends upon the sensible financial analysis of the last two years’ financial statements of the company. You can convince your boss with sound financial analysis and sensible arguments!
Extra Tech Company
Income Statements for last two years
(All in ‘000)
|
Dec 31st 2016
|
Dec 31st
2015
|
Sales
|
$
|
7650
|
$
|
11500
|
Less: Cost of sales
|
|
5800
|
|
9430
|
Gross profit
|
|
1850
|
|
2070
|
Less: Selling and Admin. Expenses
|
|
100
|
|
120
|
Less: Lease Payments
|
|
50
|
|
50
|
EBIT
|
|
1700
|
|
1900
|
Less: Interest
|
|
50
|
|
350
|
EBT
|
|
1650
|
|
1550
|
Less: Taxes
|
|
600
|
|
550
|
EAT (Net Income)
|
|
1050
|
|
1000
|
Dividends paid
|
|
300
|
|
300
|
Transferred to retained earning
|
|
750
|
|
700
|
|
|
|
|
|
Balance Sheet for last two years
|
|
Dec 31st
2016
|
Dec 31st
2015
|
ASSETS
|
|
|
|
|
Current Assets
|
$
|
$
|
$
|
$
|
Cash
|
900
|
|
50
|
|
A/Receivable
|
1200
|
|
3800
|
|
Inventory
|
1500
|
|
2450
|
|
Total Current assets
|
|
3600
|
|
6300
|
Fixed Assets
|
|
10050
|
|
11350
|
Total assets
|
|
13650
|
|
17650
|
LIABILITIES
|
|
|
|
|
Current Liabilities
|
|
|
|
|
A/Payable
|
1800
|
|
2150
|
|
Tax payables
|
600
|
|
550
|
|
Total Current Liabilities
|
|
2400
|
|
2700
|
Long term Debt
|
|
350
|
|
3350
|
Total Liabilities
|
|
2750
|
|
6050
|
SHAREHOLDERS' EQUITY
|
|
|
|
|
Common Stock, $10 par
|
5900
|
|
5900
|
|
Retained Earnings
|
5000
|
|
5700
|
|
Total Shareholders' Equity
|
|
10900
|
|
11600
|
Total Liabilities. & Shareholder’s Equity
|
|
13650
|
|
17650
|
Requirements:
This is an individual project.
Part A:
(You can use MS-Excel to do the ratios)
Cover Page (1 mark)
Table of contents (1 mark)
Executive Summary (2 marks)
Calculate the following key ratios for year 2015 - 2016; (8 marks)
(i) Profit margin ratio (ii) Return on Equity Ratio (iii) Receivables turnover (iv) Inventory turnover (v) Fixed assets turnover (vi) Current Ratio (vii) Quick ratio (viii) Debt to total assets
(ii) Analyze the financial statements of Extra Tech Company for both years and comment in detail over the financial health of the company during year 2016 under four areas: (40 marks)
- Liquidity
- Asset Utilization
- Debt Utilization
- Profitability
(iii) Provide suggestions for improvements for each of these four areas. (8 marks)
Part B:
You will use MS-Excel to do the calculations in this case.
(Use a different worksheet for each of these proposals – Ex:
Sheet 1
– Proposal A;
Sheet 2
– Proposal B…)
1. Calculate the Cash flows for each of the proposals. (16 marks)
2. Calculate the following for each of the proposals in the case
a. Net Present value (NPV) (4 marks)
b. Internal rate of return (IRR) (4 marks)
Alternative Scenario:
3. What would happen if operating cost were 8% higher than expected and revenue is 5% lower than the expected?
Note: Calculate BOTH evaluation methods again and check whether your decision will change? If yes - Why? (12 marks)
4. Provide recommendation as to which proposal should be adopted in each scenario and the reasons for your recommendation in order to address his concerns and convince him of your choice. (4 marks)
SUBMISSION REQUIREMENTS
You will
submit
the following:
a. The Excel spreadsheet – complete with calculations
b. Financial Statements Analysis Report to the CEO
c. Capital Budgeting Analysis report justifying your decisions
d. Word limit is 2500-3000 words for the report (excluding calculations)
e. Font: Times New Roman; size 12; 1.5 spacing.