BUS 4183 – Corporate Finance
Capital Budgeting – Case Study
Assume that as a financial management trainee at HiTech Horizon 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 10% minimum acceptable rate of return. The company uses a straight-line method for calculating depreciation and the company’s tax rate is 33%.
Proposal –A:
This proposal is to buy machine. Machine is six years old and was considered a good buy at $300,000. 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
(300,000)
Additional Revenue
44,000
78,000
112,300
225,000
168,750
Additional operating costs
11,250
12,000
12,500
13,000
14,000
Depreciation
60,000
60,000
60,000
60,000
60,000
Proposal –B:
This proposal is to diversify into 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
(700,000)
Additional Revenue
87,500
175,000
262,500
393,750
525,000
Additional operating costs
26,000
27,000
29,000
30,000
32,000
Depreciation
18000
18000
18000
18000
18000
Proposal—C:
This proposal is to buy a Jet. The Jet was expensive and, counting additional training and licensing requirements. However, the versatility that the Jet was expected to provide would generate over $1.5 million in revenue, and 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)
Additional Revenue
200,000
300,000
400,000
450,000
500,000
Additional operating costs
60,000
85,000
95,000
98,000
105,000
Depreciation
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 $51,000 each, and the additional business would bring in almost $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
(510,000)
Additional Revenue
382,500
325,125
89,250
76,500
51,000
Additional operating costs
31,000
31,000
31,000
31,000
31,000
Depreciation
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 10% than expected and revenue might decrease by 5% than the expected!
You are planning to use payback, 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 budget 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!
HiTech Horizon Company
Income Statements for the year ended Dec 31, 2015
(All in ‘000)
2014
2015
Sales
$
7650
$
11500
Less: Cost of sales
5800
9430
Gross profit
1850
2070
Less: Selling and Admin. Expenses
100
75,000
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 Sheets as at Dec 31, 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)
Analyze the financial statements of HiTech Horizon Company for both years and comment in detail over the financial health of the company during year 2015 under four areas:
1. Liquidity
2. Asset Utilization
3. Debt Utilization
4. Profitability
Note: A detailed analysis is expected in each of these four areas with suggestions for improvement.
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.
2. Calculate the following for each of the proposals in the case
a. Payback period ( you can approximate pay back period)
b. Net Present value (NPV)
c. Internal rate of return (IRR)
Alternative Scenario:
3. What would happen if operating cost were 10% higher than expected and revenue is 5% lower than the expected?
Note: Calculate all THREE evaluation methods again and check whether your decision will change? If yes – Why?
4. Write a report to your CEO about the financial health of the company.
a. Your report should include your complete financial analysis
b. 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.
SUBMISSION REQUIREMENTS
5. You will submit the following:
a. The Excel spreadsheet – complete with calculations
b. Financial Statements Analysis Report to the CEO
Due Date: Sunday, 13th April – 2016 (Week 14) 12:00 P.M as per UAE time
**Kindly note that i may miss calculate the number of problems, please solve the whole requirements and if there any additional fees are needed i will pay it. ( the calculation and the financial statement)
Also you are requested to send the answer to my email ( [email protected] and [email protected])
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