Concept explainers
Cost of Capital for Swan Motors
You have recently been hired by Swan Motors, Inc. (SMI) in its relatively new treasury management department. SMI was founded eight years ago by Joe Swan. Joe found a method to manufacture a cheaper battery that will hold a larger charge, giving a car powered by the battery a range of 700 miles before requiring a charge. The cars manufactured by SMI are midsized and carry a price that allows the company to compete with other mainstream auto manufacturers. The company is privately owned by Joe and his family, and it had sales of $97 million last year.
SMI primarily sells to customers who buy the cars online, although it does have a limited number of company-owned dealerships. Most sales are online. The customer selects any customization and makes a deposit of 20 percent of the purchase price. After the order is taken, the car is made to order, typically within 45 days. SMI’s growth to date has come from its profits. When the company had sufficient capital, it would expand production. Relatively little formal analysis has been used in its capital budgeting process. Joe has just read about capital budgeting techniques and has come to you for help. For starters, the company has never attempted to determine its cost of capital, and Joe would like you to perform the analysis. Because the company is privately owned, it is difficult to determine the
2. To estimate the cost of equity for TSLA, go to finance. yahoo.com and enter the ticker symbol TSLA. Follow the links to answer the following questions: What is the most recent stock price listed for TSLA? What is the market value of equity, or market capitalization? How many shares of stock does TSLA have outstanding? What is the most recent annual dividend? Can you use the
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Fundamentals of Corporate Finance
- Arnold Vimka is a venture capitalist facing two alternative investment opportunities. He intends to invest $1,000,000 in a start-up firm. He is nervous, however, about future economic volatility. He asks you to analyze the following financial data for the past year's operations of the two firms he is considering and give him some business advice. Variable cost per unit (a) Sales revenue (8,600 units x $31.00) Variable cost (8,600 units x a) Contribution margin Fixed cost Net income Company Name Larson $ 20.00 $ 266,600 (172,000) $ 94,600 (25,000) $ 69,600 Benson $ 10.00 $ 266,600 (86,000) $ 180,600 (111,000) $ 69,600 Required a. Use the contribution margin approach to compute the operating leverage for each firm. b. If the economy expands in coming years, Larson and Benson will both enjoy a 11 percent per year increase in sales, assuming that the selling price remains unchanged. Compute the change in net income for each firm in dollar amount and in percentage. (Note: Since the number…arrow_forwardArnold Vimka is a venture capitalist facing two alternative Investment opportunities. He intends to invest $1,000,000 in a start-up firm. He is nervous, however, about future economic volatility. He asks you to analyze the following financial data for the past year's operations of the two firms he is considering and give him some business advice. Variable cost per unit (a) Sales revenue (8,100 units × $28.00) Variable cost (8,100 units x a) Contribution margin. Fixed cost Net income Required A Variable cost per unit Sales revenue Variable cost Contribution margin Required a. Use the contribution margin approach to compute the operating leverage for each firm. b. If the economy expands in coming years, Larson and Benson will both enjoy a 11 percent per year Increase in sales, assuming that the selling price remains unchanged. Compute the change in net income for each firm in dollar amount and in percentage. (Note: Since the number of units Increases, both revenue and variable cost will…arrow_forwardArnold Vimka is a venture capitalist facing two alternative investment opportunities. He intends to invest $1,000,000 in a start-up firm. He is nervous, however, about future economic volatility. He asks you to analyze the following financial data for the past year's operations of the two firms he is considering and give him some business advice. Variable cost per unit (a) Sales revenue (8,300 units × $29.00) Variable cost (8,300 units x a) Contribution margin Fixed cost Net income Required a. Use the contribution margin approach to compute the operating leverage for each firm. b. If the economy expands in coming years, Larson and Benson will both enjoy a 11 percent per year increase in sales, assuming that the selling price remains unchanged. Compute the change in net income for each firm in dollar amount and in percentage. (Note: Since the number of units increases, both revenue and variable cost will increase.) c. If the economy contracts in coming years, Larson and Benson will both…arrow_forward
- Eastern Auto Supply Limited produces and distributes auto supplies. The company is anxious to enter the rapidly growing market for long-life batteries that is based on lithium technology. Management believes that to be full competitive the new battery that the company is planning can’t be priced at more than Tk. 130. At this price management is confident that the company can sell 100,000 batteries per year. The batteries would require an investment of Tk. 5,000,000 and the desired ROI is 20%. Required: Compute the target cost of one battery.arrow_forwardYou recently went to work for Allied Components Company, a sup-plier of auto repair parts used in the after-market with products from Daimler AG, Ford, Toyota, and other automakers. Your boss, the chief financial officer (CFO), has just handed you the estimated cash flows for two proposed projects. Project L involves adding a new item to the firm’s ignition system line; it would take some time to build up the market for this product, so the cash inflows would increase over time. Project S involves an add-on to an existing line, and its cash flows would decrease over time. Both projects have 3-year lives because Allied is planning to introduce entirely new models after 3 years. Here are the projects’ after-tax cash flows (in thousands of dollars): 02 1 Project L Project S ⫺$100 ⫺$100 $10 $70 $60 $50 3 $80 $20 Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. The CFO also made subjective risk assessments of…arrow_forwardArnold Vimka is a venture capitalist facing two alternative investment opportunities. He intends to invest $1,000,000 in a start-up firm. He is nervous, however, about future economic volatility. He asks you to analyze the following financial data for the past year's operations of the two firms he is considering and give him some business advice. Variable cost per unit (a) Sales revenue (8,100 units $30.00) Variable cost (8,100 units a). Contribution margin Fixed cost Net income Company Name Larson $18.00 $243,000 (145,800) $ 97,200 (25,000) $ 72,200 Company Name Operating leverage Benson $9.00 Required a. Use the contribution margin approach to compute the operating leverage for each firm. b. If the economy expands in coming years, Larson and Benson will both enjoy a 10 percent per year increase in sales, assuming that the selling price remains unchanged. Compute the change in net income for each firm in dollar amount and in percentage (Note: Since the number of units increases, both…arrow_forward
- Castle View Games would like to invest in a division to develop software for a soon- to-be-released video game console. To evaluate this decision, the firm firstattempts to project the working capital needs for this operation. Its chief financial officer has developed the following estimates (in millions of dollars): Year 1 Year 2 Year 3 Year 4 Year 5 Cash 6. 12 15 15 15 Accounts receivable 21 22 24 24 24 Inventory Accounts payable 5 7 10 12 13 18 22 24 25 30 If Castle View currently does not have any initial working capital invested in this division, calculate the cash flows associated with changes in working capital for the first five years of this investment. 3.arrow_forwardYou have founded a company to sell thin client computers to the food processing industry for Internet e-commerce transaction processing. Before investing in your new company, a venture capitalist has asked for a five year pro-forma income statement showing unit sales, revenue, total variable cost, marketing expense, fixed cost, and profit before tax. You expect to sell 1,600 units of the thin client computers in the first year for a price of $1,800 each. Swept along by Internet growth, you expect to double unit sales each year for the next five years. However, competition will force a 15% decline in price each year. Fortunately, technical progress allows initial variable manufacturing costs of $1,000 for each unit to decline by 6% per year. Fixed costs are estimated to be $1,000,000 per year. Marketing expense is projected to be 14% of annual revenue. When it becomes profitable to do so, you will lease an automated assembly machine that reduces variable manufacturing costs by 20% but…arrow_forwardes eEgg is considering the purchase of a new distributed network computer system to help handle Its warehouse Inventories. The system costs $55,000 to purchase and install and $32,000 to operate each year. The system is estimated to be useful for 4 years. Management expects the new system to reduce the cost of managing Inventories by $60,000 per year. The firm's cost of capital (discount rate) is 10%. Required: 1. What is the net present value (NPV) of the proposed Investment under each of the following Independent situations? (Use the appropriate present value factors from Appendix C, TABLE 1 and Appendix C. TABLE 2.) 1a. The firm is not yet profitable and therefore pays no income taxes. 1b. The firm is in the 22% Income tax bracket and uses straight-line (SLN) depreciation with no salvage value. Assume MACRS rules do not apply. 1c. The firm is in the 22% Income tax bracket and uses double-declining-balance (DDB) depreciation with no salvage value. Given a four-year life, the DDB…arrow_forward
- The Castillo Products Company was started in 2008. The company manufactures components for personal decision assistant (PDA) products and for other handheld electronic products. A difficult operating year, 2009, was followed by a profitable 2010. The founders (Cindy and Rob Castillo) are interested in estimating their cost of financial capital since they are expecting to secure additional external financing to support planned growth. Short-term bank loans are available at an 8 percent interest rate. Cindy and Rob believe that the cost of obtaining long-term debt and equity capital will be somewhat higher. The real interest rate is estimated to be 2 percent and a long-run inflation premium is estimated at 3 percent. The interest rate on long-term government bonds is 7 percent. A default-risk premium on long-term debt is estimated at 6 percent; plus Castillo Products is expecting to have to pay a liquidity premium of 3 percent due to the illiquidity associated with its long-term…arrow_forwardThe Castillo Products Company was started in 2008. The company manufactures components for personal decision assistant (PDA) products and for other handheld electronic products. A difficult operating year, 2009, was followed by a profitable 2010. The founders (Cindy and Rob Castillo) are interested in estimating their cost of financial capital since they are expecting to secure additional external financing to support planned growth. Short-term bank loans are available at an 8 percent interest rate. Cindy and Rob believe that the cost of obtaining long-term debt and equity capital will be somewhat higher. The real interest rate is estimated to be 2 percent and a long-run inflation premium is estimated at 3 percent. The interest rate on long-term government bonds is 7 percent. A default-risk premium on long-term debt is estimated at 6 percent; plus Castillo Products is expecting to have to pay a liquidity premium of 3 percent due to the illiquidity associated with its long-term…arrow_forwardYou are the financial analyst for furniture manufacturer. The company is considering using a certain new raw material in its furniture. The company has estimated the information in the following table about the market for a chair with the new material. The company expects to sell the chair for six years. The equipment required for the project has no salvage value. The required return for projects of this type is 13 percent, and the company has a 40 percent tax rate. Pessimistic Expected Optimistic Market size 130,000 150,000 165,000 Market share 21% 25% 28% Selling price $140 $145 $150 Variable costs per unit $102 $98 $94 Fixed costs per year $1,015,000 $950,000 $900,000 Initial investment $2,200,000 $2,100,000 $2,000,000 Required: Should you recommend the project?arrow_forward
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