MBA 620_P5_Final_Princess_Report_date

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Project 5: Cost of Capital, Risk/Return, and Capital Budgeting MBA 620 9047 Financial Decision Making (2232)

Project 5: Cost of Capital, Risk/Return, and Capital Budgeting 1. How would you assess the evolution of the capital structure of LGI? Reflecting on your work in Project 1, would you consider the risk exposure under control? If not, what are your recommendations? LGI’s capital structure evolution looks to be on the positive side given it moves forward with the changes proposed throughout the 5 projects. A company’s capital structure is the mix of debt and equity the company uses to finance its business (Clayman et al., 2012). Securing the sale of its underperforming assets for the Bowie plant will help in generating much needed cash flow to the company to divert its investment activities towards the acquisition of a robotics-based sorting and distribution equipment to facilitate a more cost-effective operations at its Largo facility. This will help the company utilize its resources efficiently and help in maximization of profit for possible investment and development opportunities in the near future. Reflecting on the data calculated for LGI in Project 1, we can consider that the risk exposure for the company was not under control. The company’s long-term debt and current liabilities continues to see a rise over the course of the three years period as calculated on its balance sheets. The debt-to-equity (D/E) ratio for LGI was recorded higher than the industry average of 0.27 for three consecutive years at 0.33, 0.31, and 0.30. ‘Lenders and debt investors prefer lower D/E ratios as that implies there is less reliance on debt financing to fund operations – i.e. working capital requirements such as the purchase of inventory (Wall Street Prep, n.d.). It is crucial for LGI to improve its debt management to keep its control its risk exposure. The Income statement for the company reflects continuing decline in its net sales resulting in decline of its profit from $968 million in 2018 to $613 million in 2020. LGI needs to increase and utilize all of its resources to its optimum to increase its sales and revenue to meet its debt obligations.

Project 5: Cost of Capital, Risk/Return, and Capital Budgeting 2. What kind of information do you find valuable in CAPM to guide you in assessing the risk of LGI compared to other firms and the market in general? Capital Asset Pricing Model (CAPM) describes the relation between risk and expected return. It defines the relation of systematic risk and return as linear and that the risk-free rate of return is the appropriate return for an asset with no systematic risk (Parrino et al., 2021). This model is used in the finance sector to assess the rate of return needed for an investment with a particular amount of systematic risk. Utilizing the CAPM is valuable in assessing LGIs risks against its competitors in the industry. The expected return for a portfolio can also be predicted using the CAPM (Parrino et al., 2021). The expected return calculated by the CAPM can be used a benchmark for assessing whether the expected returns for individual assets are sufficient. When the expected return is lower than that CAPM predictions the investment is not profitable and conversely an investment is profitable when the expected return is higher (Parrino et al., 2021). It also helps in assessing the pricing of LGIs assets and the associated risks of the volatile market conditions. Analyzing the expected return on LGIs assets at various Beta points and systematic risks depending on the market portfolio helps its managers to make sound financial decisions. This information is also crucial to its investors in assessing the risks with LGI in comparison to other companies in the industry to determine if the investment is worth the risk based on the expected rate of return. 3. Identify and differentiate the stakeholders of LGI and explain how each one should perceive and weigh the risk and/or return of the firm.

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Project 5: Cost of Capital, Risk/Return, and Capital Budgeting LGIs key stakeholders include its investors/shareholders, suppliers/vendors, employees, end user/customer, and the government. Investors/Shareholders: These are LGIs internal stakeholder with a vested interest in the company. The return on investment is the primary concern for the company’s investors and shareholders. The profit potential in terms of dividends per shares, the price per share and the valuation of its stocks in the market is a key factor in weighing the risk and /or return of LGI. Suppliers/Vendors: These are LGIs external stakeholders having a direct impact on their revenue in regard to its business operations with the company. As such they weigh in the risk/return based on LGIs ability to make timely payments for the supplies and materials provided for its manufacturing and distribution activities. Employees: LGI’s employees are its internal stakeholders. The primary factor for the employees to weigh the risks/returns is LGIs ability to compensate for the services and labor provided to the company and the job/income security. They might perceive LGIs acquisition of robotics- based sorting and distribution equipment as a risk associated with job security. Customer/End user: LGIs customers or the end user of its products are its external stakeholders who are primarily concerned with the quality of goods and services LGI is able to offer at an optimal purchase point. They weigh the risks/return of LGI based on the availability of quality of products at a desirable price point offered compared to its competitors in the market. Government: The government is LGIs external stakeholder responsible for initiating and regulating various policies, rules, and regulations. Apart from LGI complying with all the

Project 5: Cost of Capital, Risk/Return, and Capital Budgeting industry rules and regulations, the taxes applicable on the company’s overall profit or return is an area of concern for this entity as its stakeholder. 4. Would you consider the investment made in Project 4 optimally financed considering the proportion of debt that is bearable by LGI? How did the current WACC in Project 5 depart from the state of the firm in Project 1? Considering the proportion of LGIs debt versus its proportion of equity against the company’s total capital, I would consider the investment made in Project 4 optimally financed. Analyzing the current calculation for the WACC in Project 5, LGI’s weight of equity is 89.33% compared to its weight of debt at 10.67%. This is a positive indication of LGI’s low debt amount which accounts to lower interest payments on its debts, lower chances of bankruptcy and fewer risks for its potential investors in the market. LGI’s weighted average cost of capital is at 8.12%. A lower WACC is desirable for a firm to attract potential investors at a comparatively lower price as its is an indication of low risk in the market. 5. If you had to advise a potential investor interested in having a minority stake in LGI, what kind of information would you provide to help the investor make a decision? Would you be bullish or have reservations? Support your answer with facts and data from all MBA 620 projects as well as your budget projections . Taking the data points available across the years for the company, as well as analyzing the projections throughout the projects, I would not have any reservations if I were to advise a potential investor interested in having a minority stake in LGI. The data provided in Project 1 pointed towards the concerning financial health of the company in terms of sales and revenue.

Project 5: Cost of Capital, Risk/Return, and Capital Budgeting However, in terms of financial leverage, the debt-to-equity ratio over the three years range was 0.33, 0.31, and 0.30 which is slightly higher than the industry 0.27 and provides an insight on the amount of debt for each dollar of equity (Parrino et al., 2012). The retained earnings as well as stock and the stockholder equity continued to rise over the years. Project 2 reflected on the impact of the demand and supply and price elasticity on LGI and its operations to maximize profitability on its products, Standard, Deluxe as well as sustainable boxes. The data points calculations helped to determine the optimal pricing and demand for each of its product in the market which help the business make informed financial decisions to increase its operational efficiency to provide the greater manufacturing capabilities and ultimately increase its revenue over the years while satisfying market demand of its products. Cost Allocations under the Activity-Based Costing (ABC) method in Project 3 also provided an insight into the fixed and variable costs impacting the operating profits for each of its products to subsequently address the activities that increase operational costs and overheads. This is important for the profitability of any business venture in the long run. The proposed sale of the underperforming assets of its Bowie facility and the acquisition of robotics-based sorting and distribution equipment to facilitate more cost-effective operation to handle the increased workload in Project 4 is a positive indication that the company is heading towards a better and stronger financial stance. The sale of the Bowie facility provides the company with a much-needed cash inflow and the robotics acquisition is a feasible and profitable based the positive NPV calculated at $189.45 million and the IRR of 25.84% which will both add value to the company in the long run. In a nutshell, LGI is heading towards financial growth and stability and is a very desirable option for any potential investors in the market.

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Project 5: Cost of Capital, Risk/Return, and Capital Budgeting References Clayman, M. R., Fridson, M. S., & Troughton, G. H. (2012). Corporate Finance: A Practical Approach (2nd. ed.). Wiley. https://learning.oreilly.com/library/view/corporate- finance-a/9781118105375/xhtml/contents.html Parrino, R., Kidwell, D. S., & Bates, T. W. (2012). Fundamentals of Corporate Finance. Wiley. https://learning.oreilly.com/library/view/fundamentals-of-corporate/ 9780470876442/?ar University of Maryland Global Campus. (n.d.). Analyzing Financial Statements . Document posted in UMGC MBA 620 9047 online classroom, archived at https://learn.umgc.edu Wall Street Prep. (n.d.) Leverage Risk Analysis https://www.wallstreetprep.com/knowledge/debt-to-equity-ratio/

MBA 620_P5_Final_Princess_Report_date

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