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Feb 20, 2024

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Exercise: Alpha Corporation • Alpha Corporation has three major divisions. Current results for the three divisions are summarized below. • Complete the worksheet on the following page. Which divisions are value creators? Which are value destroyers? WACC 12% Stand Dev per year 40% Tax rate 35% Risk Free return 3% Division A Division B Division C Total Sales $43,000 $10,000 $22,000 $75,000 Operating income $7,692 $2,462 $4,615 $14,769 Invested capital $25,000 $20,000 $10,000 $55,000

Exercise: Alpha Corporation • Separately evaluate each of the following initiatives in terms of their effect on the performance of the division involved and the company as a whole. Which initiatives do you support? Why? – Division A is considering an acquisition of a company with annual sales of $5,000 and a pre-tax operating margin of 15%. The acquisition will cost $10,000. The target company is one of the few remaining with access to a key distribution network. Without access to distribution, division C might become worthless 3 years from now (not before) depending on how the industry consolidates. The probability division C will become worthless is 50% without the acquisition but 0% with it. What should you do? – How does your decision change if the probability division C could become worthless is 50% per year starting now – Division A has an unused factory with a book value of 10,000. They can sell it today for 12,000. The factory contains technology that would permit the company to sell 10,000 of product with 30% operating margins with an additional investment of 10,000 if the tax laws change. If the tax laws do not change, the factory will be worthless. The probability of the change is 40% per year for the next 3 years when the next election happens. After the next election, the law will not change. What should you do? It costs nothing to leave the factory empty.

Alpha Continued • Division B has a new product idea that will increase annual sales for the division by $8,022 and earn a pre-tax operating margin of 28%. The new product will require an additional $5,000 of invested capital. A key competitor is rumored to be planning a similar new product. If the competitor moves first, our revenues will be cut in half. Some in the organization propose to wait until the results of a research project are available 1 year from now that will prove the product’s technical feasibility. Others propose to move now. If you move now and the product fails, the cost will be $5,000. What is your choice?

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Exercise Continued  Division C is considering exiting one of their least profitable markets. If they exit the market, they will lose 4,000 in revenues and 350 in pre-tax operating income. They will also be able to free 3,500 of capital for other uses. There is a research project to lower cost which would expand the pre-tax operating income to 900 that will be complete in 1 year. The probability the research project will yield the cost savings is 50%. What should you do?

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