FINANCIAL MANAGEMENT (BFF3013 /BAFF3013)

Small Group Project: Financial Case Study Analysis (40 Marks)

The purpose of this assignment is to provide a "hands on" experience to synthesize the
financial management concepts that you have learned throughout the semester by
applying them to a "real life" company. You'll also have an opportunity to work with fellow
class members and "pick each other's brains" as you research your case and present
the results of your analysis in paper and 15-minute class presentation.
Here's what you need to do:
1. Form a group of 4 and notify the instructor of your group members.
2. Discuss all 4 case studies attached.
3. Prepare a written team report to answer the questions for each case
4. Submit the case as per the due date given.
5. For RCs students. Although your lecturer will evaluate your report, you are
required to send a hard copy for each case submitted in Voiss / SMS. I will
randomly check your report. Those who fail to submit the written report, marks
will be deducted.
6. Deliver a 15-minute team group presentation about the case at the end of the
semester.

CASE 1: Kayu Kertam Furniture Company (Cash Flow) 10 marks

Due date 12 October 2012
Kayu Kertam Furniture Company is considering adding a new line to its product mix, and
the capital budgeting analysis is being conducted by Joan Abdullah, a recently
graduated finance major from UMTECH. The production line would be set up in unused
space in Kertam's main plant. The machinery's invoice price would be approximately
RM200,000; another RM10,000 in shipping charges would be required; and it would cost
an additional RM30,000 to install the equipment.
Further, the firm's inventories would have to be increased by RM25,000 to handle the
new line, but its accounts payable would rise by RM5,000. The machinery has an
economic life of 4 years, and Kertam has obtained a special tax ruling which places the
equipment in the MACRS 4-year class. The machinery is expected to have a salvage
value of RM25,000 after 4 years of use. The new line would produce incremental unit
sales of 1,250 at a price of RM200 in each of the next four years. Incremental cash
operating costs would equal 50 percent of the new line's gross revenue. Therefore,
incremental operating profit, before depreciation and taxes, would equal RM125,000 in
each of the next four years. The firm's tax rate is 40 percent, and its overall weighted
average cost of capital is 10 percent.
Questions:
a. Construct incremental operating cash flow statements for the project's 4 years of
operations.
b. Does your cash flow statement include any financial flows such as interest
expense or dividends? Why or why not?
c. Suppose the firm had spent RM100,000 last year to rehabilitate the production
line site. Should this cost be included in the analysis? Explain.
d. Now assume that the plant space could be leased out to another firm at
RM25,000 a year. Should this be included in the analysis? If so, how?[
e. Finally, assume that the new product line is expected to decrease sales of the
firm's other lines by RM50,000 per year. Should this be considered in the
analysis? If so, how?
f. Disregard the assumptions in Part c:
1. What is Kertam's net investment outlay on this project?
2. What is the net non operating cash flow at the time the project is
terminated?
3. Based on these cash flows, what are the project's NPV and payback? Do
these indicators suggest that the project should be undertaken?
g. Assume now that the project is a replacement project rather than a new, or
expansion, project. Describe how the analysis would differ for a replacement
project.

h. Explain what is meant by cash flow estimation bias. What are some steps that
Kertam's management could take to eliminate the incentives for bias in the
decision process?
i. Do you think its likely that the project being considered here might have
managerial option value over and above the indicated NPV? If so, how might this
be handled?
j. Assume that inflation is expected to average 5 percent over the next 4 years.
Does it appear that Kertam's cash flow estimates are real or nominal? That is,
are all the cash flows stated in Time 0 dollars or have the cash flows been
increased to account for expected inflation?
k. Further, would it appear that the 10 percent cost of capital is a nominal or real
rate? Does it appear that the current NPV is biased because of inflation effects?
If so, in what direction, and how could any bias be removed?
Adapted: http://www.cbe.wwu.edu/Hall/FMDS441/i5-im08b.pdf

Case 2: Anjung Merah Mini Case Capital Structure Decision 10 marks

Due date 25 October 2012
Assume you have just been hired as Finance Manager of Anjung Merah. The companys
earnings before interest and taxes (EBIT) was RM500,000 last year and is expected to
remain constant (in real terms) over time. Since no expansion capital will be required,
Anjung plans to pay out all earnings as dividends. The management group owns fifty
percent (50%) of the stock and the rest is traded in the over-the-counter market. You are
currently enrolled in a MBA program. In your finance course, you learned that most firm
owners would be financially better off if the firm used some debt. When you suggested
this to your new boss, she encouraged you to pursue the idea. Anjung is currently
financed with all equity, it has 100,000 shares outstanding and the current market price
is RM15 per share. If Anjung were to recapitalize, debt would be used and the funds
received would be used to repurchase stock at the RM15.00 per share market price.
Anjung is in a 40% federal plus state tax bracket. The company leases all of its
equipment and its building. Therefore, Anjung has no depreciation expense.
From your finance training, you know that there is an optimum relationship between debt
and equity at which the market value per share will be maximized. You recall that you
can use estimated cash flows, weighted average cost of capital (WACC), and the capital
asset pricing model (CAPM) to estimate share
value. As a first step you found the following information on Yahoo finance:
The current prime borrowing rate is 5% and the current risk free rate (30 year Treasury
bond) is 4%. You estimate the market risk premium into the foreseeable future at 8%.
Next, you obtained from a local investment banker the following estimated debt risk
premiums and subjective betas for Anjung at various debt levels:
Scenario
1
2
3
4
5
6
7

Amount Borrowed
RM0
RM187,500
RM375,000
RM562,500
RM750,000
RM937,500
RM1,125,000

Debt Risk Premium

2.0%
2.0%
2.5%
3.5%
5.0%
7.0%
10.0%

Subjective Beta
2.0
2.1
2.3
2.5
2.9
3.3
3.7

Questions:
a.
b.
c.
d.

What will be the amount of equity after repurchase of stock under each debt scenario
What will be the weights of debt and equity under each debt scenario?
What will be the after-tax cost of debt under each debt scenario?
What will be the cost of equity (CAPM) under each debt scenario?

e. What will be the weighted average cost of capital (WACC) under each debt
scenario?
f. How many shares will be repurchased and how many will remain outstanding under
each debt scenario?
g. What is the estimated total asset value and total equity value under each debt
scenario? Hint: Total Asset = Earning/WACC
h. What is the estimated market value per share under each debt scenario?
i. It is also useful to determine the effect of recapitalization on earnings per share.
Calculate the EPS under each debt scenario.
j. Briefly explain the trade-offs between debt and equity financing.
*** Tabulate your Answer where possible

Case 3: Leverage and BEP 10 marks

Due date 9 November 2012

Select two companies that are competitors, or at least are in the same industry
even if they do not directly compete with each other. Analyze their 2011 annual
report.Provide a summary report of the results from an analysis and then
compare along the following dimensions: i.
Degree of Operating
Leverageii.
Degree of Financial Leverageiii. Degree of Total
Leverageiv. Contribution Margin and Contribution Margin Ratiov.
Break
Even Margin
n order to perform this task, you need to first separate costs into fixed and
variable components. Thus, you will first need to estimate the percentage [%]
variable and fixed costs for each cost category. Apply the High Low
Technique to assess cost behavior.

Show All Workings.

Case 4: Electronic Timing Inc (Dividends and Dividend Policy) 10 marks

Due date 30 November 2012
Electronic Timing Inc (ETI), is a small company founded 15 years ago by electronics
engineers Tom Miller and Jessica Kerr. ETI manufactures integrated circuits to capitalize
on the complex mixed-signal design technology and has recently entered the market for

frequency timing generators, or silicon timing devices, which provide the timing signals
or clicks necessary to synchronize electronic systems. It clocks products originally
were used in PC video graphics applications, but the market subsequently expanded to
include motherboards, PC peripheral devices, and other consumer electronics, such as
digital television boxes. ETI also designs and market custom application-specific
integrated circuits (ASICs) for industrial customers.
In addition to Tom and Jessica, Nolan Pittman, who provided capital for the company, is
the third primary owner. Each owns 25% of the 1 million shares outstanding. The
company has several other individuals, including current employees, who own the
remaining shares.
Recently, the company designed a new computer motherboard. The companys design
is both more efficient and less expensive to manufacture, and the ETI design is expected
to become standard in many personal computers. After investigating the possibility of
manufacturing the new motherboard, ETI determined that the costs involved in building a
new plant would be prohibitive, The owners also decided that they were unwilling to
bring in another large outside owner. Instead, ETI sold the design to an outside firm. The
sale of the motherboard design was completed for an aftertax payment of $30 million.
Questions:
a. Tom believes the company should use extra cash to pay a special one-time
dividend. How will this proposal affect the stock price? How will it affect the value
of the company?
b. Jesicca believes the company should use the extra cash to pay off debt and
upgrade and expand its existing manufacturing capability. How would Jessicas
proposals affect the company?
c. Nolan favors a share repurchase. He argues that a repurchase will increase the
companys P/E ratio, return on assets and return on equity. Are his arguments
correct? How will a share repurchase affect the value of the company?
d. Another option discussed by Tom, Jessica and Nolan would be to begin a regular
dividend payment to shareholders. How would you evaluate this proposal?
e. Does the question of whether the company should pay a dividend depend on
whether the company is organized as a corporation or Limited Liability
Companies?