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
5. You used TSLA as a pure play company to estimate the cost of capital for SMI. Are there any potential problems with this approach in this situation?
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Fundamentals of Corporate Finance
- You were hired as the CFO of a new company that was founded by three professors at your university. The company plans to manufacture and sell a new product, a cell phone that can be worn like a wrist watch. The issue now is how to finance the company, with equity only or with a mix of debt and equity. The price per phone will be $250.00 regardless of how the firm is financed. The expected fixed and variable operating costs, along with other data, are shown below. How much higher or lower will the firm's expected ROE be if it uses 60% debt rather than only equity, i.e., what is ROEL - ROEU? 0% Debt, U 60% Debt, L Expected unit sales (Q) 33,500 33,500 Price per phone (P) $250.00 $250.00 Fixed costs (F) $1,000,000 $1,000,000 Variable cost/unit (V) $200.00 $200.00 Required investment $2,500,000 $2,500,000 % Debt 0.00% 60.00% Debt, $ $0 ?? Equity, $ $2,500,000 ?? Interest rate NA 10.00% Tax rate 25.00% 25.00% Group of answer choices…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
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- es 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_forwardCastle 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_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_forward
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