Final-F21

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University of Colorado, Boulder *

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FNCE 3010

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Business

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Feb 20, 2024

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docx

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Name:_________________ Final Exam MBAC 6060 Fall 2021 This is a difficult exam, but you have all the tools you need to complete it. I suggest taking the first 10 minutes to read the exam and think about what you need to do and then proceed in a methodical way. Complete the following exercise. All necessary information is provided. Perform your analysis on an annual basis (all interest rates are given as an APR with annual compounding and you should also report all interest rates in this way). You should use excel and submit an excel file (.xls or .xlsx) via the canvas page for the class. Ignore personal income taxes in your analysis. It is January 5 th , 2022 and your boss, Ralph, has charged you with evaluating his latest entrepreneurial idea. Ralph’s Bar, a disreputable drinking establishment on the island of Roatán, is a privately held firm. Because of his idle time in the mornings, Ralph has been seeking a venture to augment his income and replace his current side hustle. His latest idea is to manufacture and sell “authentic Honduran hand carved” wooden sharks. You must analyze the strategy presented below, advise Ralph on whether he should pursue his idea as presented or alter his proposed strategy , and advise him regarding the value created by his scheme, the size of the initial loan and his personal equity investment necessary to establish the desired capital structure for this venture. Ralph has been considering the purchase of a machine that will produce the “hand carved” items at a reasonable rate and cost. The machine will produce output efficiently for 4 years after which it may be sold into a second-hand market. His estimation of current market conditions leads him to propose the following strategy. Ralph suggests buying one machine immediately, operating it for 4 years, then replacing it and operating the replacement machine for the subsequent 4 years; a total of an 8-year production horizon. Ralph expects to sell 1,000 sharks in 2022 and that the number of units sold will increase by 15% each year through 2025. The growth rate for the units sold is expected to slow to 4% for the subsequent 4 years. At the end of 2029, he expects to terminate the venture, believing that the market will no longer support this product or more likely that the myth of “hand carved items” will be exposed. Ralph expects that in the first year the price will be set at $20 per unit and that this price will grow at a rate equal to the rate of inflation through 2025. For 2026 through 2029 the sales price is expected to grow at a rate 2% below the rate of inflation. To follow the strategy described above, production of this product requires the immediate purchase of a machine costing $10,000. The machine will be depreciated over 4 years on a straight-line basis for tax purposes. The used machine will be sold at the end of December 2025 for an expected $2,000. In early January of 2026, a second machine will be purchased for an expected price of $15,000. This machine will also be depreciated over 4 years on a straight-line basis and will be sold for an expected $1,000 at the end of December 2029, when Ralph’s strategic plan calls for the project to terminate.

On a per unit basis, production requires raw materials with an initial expected cost of $10.00 and labor with an initial expected cost of $5.00. For the foreseeable future, the materials cost per unit is expected to grow at a rate of 1% above the rate of inflation and per unit labor costs are expected to grow at a rate that is 1.5% above the rate of inflation. Operating expenses each year, excluding depreciation, will be $1,000 for rent of a back room at the Crow’s Nest Restaurant and $1,000 for Ralph’s salary as chief executive. To establish the venture, an initial cash balance of $1,000 and an initial $500 inventory of raw materials are required. To prepare for the next year’s production, at the end of each production year, cash equal to 5% of the next year’s anticipated sales and raw materials inventory equal to 5% of the next year’s anticipated materials expense are required. It is anticipated that at the end of each year of production (except the final year) a finished goods inventory equal to 2% of that year’s COGS will remain on hand. Other than the final year, credit sales and purchases in each year of operations are expected to create a year ending accounts receivable balance and an accounts payable balance equal to 4% of sales in that year and 8% of materials expenses in that year, respectively. Financing for the project will be set so that a debt to value ratio equal to 0.20 will be actively maintained for the life of the project. The chosen leverage ratio and the nature of the project suggest that the incremental debt financing for the project would generate a AAA rating. Ralph’s firm faces a 21% corporate tax rate. Other useful information appears below. Proposed Comps Debt to Equity Ratio (market) Equity Beta Debt Beta Woodson’s Bar 0.3 1.20 0.04 Johnson’s Bar 0.8 1.75 0.10 Smith’s Trinkets 1.8 1.45 0.15 Carvings by Jones 0.8 1.06 0.05 Other Data Treasury Bill yield, 5-year maturity, January 4 th 2022 3.40% Treasury Bond yield, 30-year maturity, January 4 th 2022 5.50% Average 5-year Treasury Bill yield 1950 – 2021 4.30% Average 30-year Treasury Bond yield 1950 – 2021 5.90% Return on S&P 500 for 2021 (including dividend yield) 24.90% Return on S&P 500 for 2021 (excluding dividend yield) 20.10% Average return on S&P 500 1950 – 2021 (including dividend yield) 9.30% Average return on S&P 500 1950 – 2021 (excluding dividend yield) 6.90% Expected Inflation Rate 3.0% Average Inflation Rate 1950 – 2021 2.6% Ralph’s Sister’s Shoe Size 7 ½

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