Currently, Flash memory enjoy the good reputation of its products and continue to focus on R&D which allows the company to maintain its competitive advantage. An investment opportunity in a new product line that has the potential to be extremely profitable is presented to flash memory as well. Significant investments in and the new product line requires increasing working capital. Therefore, flash memory has a strong need of financing as low profit margin doesn’t provide enough cash flows for the future growth and the company also reach the bank’s lending limit. Three alternatives for additional financing are available for consideration.This report analyzes the new project based on the estimated WAC to decide if Flash memory should accept or reject this project. Furthermore, the report prepares three years pro-formal for 2010, 201 1, 2012 to show the impact on the income statement with and without the new project so that financing requirements based on each scenario can be determined.
Additionally, this report lists the pros and cons of three financing alternatives: obtaining external financing through factoring group or a private sale of common stock; rely solely on Internal financing through reinvestment f Flash’s earnings.Finally, this report makes recommendations to the board of directors about the investment decision on the new product line associated with the source of financing. IQ: Forecast income statements and balance sheets for 2010, 2011 and 2012 In the forecast income statements, we use average balances of the current and prior year amounts of notes payable to calculate interest expense. Because the balance of notes payable of 201 0 and 201 1 are over 70% of the balance of accounts receivable, which illustrates hat the company has to raise additional fund at Prim+6%, I.
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. 9. 25%. Assuming the company does not invest in the new product line, based on the assumptions in the case, we have projected the notes payable balance for 201 0, 2011, and 2012 will be and $13,41 8,000 respectively. Q: Estimate the WAC, Calculate NAP of the project.
In our forecast financial statements, the average capital structure is: We choose STET, Inc. As comparable company because they have similar size and ROE but different capital structure. STET, Inc. Doesn’t have any debt, we assume the beta of the STET, Inc. S unleavened beta or beta of assets. Therefore, by using the formula: And also assume the beta of debt is zero, the beta of Flash Memory equals 1.
84 The cost of equity equals 14. 74%. WAC equals 10. 51 We have calculated the WAC to be 10. 51%. Based on this WAC, the NAP of the new project is estimated to be $3,322,000.
Because this project has a positive NAP and provides growth opportunities for the company overall, we recommend to proceed it. Q: The impact of the proposed investment project on forecast income statement and balance sheetWe consider different scenarios, specially, if the company decide to raise fund by equity financing, it doesn’t need to seek more bank borrowings so that it is able to stay at current interest rate level, 7. 25%.
Equity financing will enable the company gain more profits compared to debt financing. In specific, the net profits of 201 0, 2011 and 2012 are and In respect of notes payable, if the company raises the fund by debt financing, the notes payable they need for the three years are $21 $24,170,000 and $19, 102,000, respectively.The sharply increase of notes payable stems room incremental debt which is used to finance both the fixed assets but also the increased net working capital. Q: Recommendation We recommend the company finance this project by equity.
First of all, we believe high tech company need multiple sources of financing because they need to invest heavily into R; they need fund to finance its daily operation as well as new projects. Solely rely on the debt may substantially increase the debt-to-equity ratio and the risk of finance distress. In the meantime, the financing cost will increase as well in this case.