1. The September 30, 2004 financial statements for Millipore Company are provided on the following page. Millipore's chief financial officer has asked you to prepare a proforma income statement, balance sheet, and statement of external financing required (EFR) for Millipore Corp for the 2005 fiscal year. The Statement of EFR should show the total financing required, the internal sources, and any adjustments to EFR. The following forecasts for the 2005 fiscal year are available:
- The company's sales are forecasted to increase by 32%.
- Cost of goods sold are expected to be 70.8% of sales.
- Selling and administration expenses will increase by $80,000.
- Amortization will increase by $10,000 since the company is planning to acquire new fixed assets that will cost $628,200.
- Lease Payments will remain unchanged.
- Interest expense will increase by $15,000.
- Millipore's tax rate is 20%.
- The company's policy is to pay 25% of their net income after tax as common share dividends.
- The firm wishes to have a minimum cash balance of $45,000.
- The company's goal is to have an average collection period of 65 days, an average age of inventory of 72 days, and an average payment period of 85 days.
- Accruals will increase by $5,000.
- During the 2005 fiscal year, the company is required to repay $205,000 of the principal on their outstanding long-term debt.
Any external financing required will be raised as follows: 60% line of credit, 40% sale of common shares.
Millipore Corp Income Statement
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ProForma
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2004
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2005
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Sales (all on credit)
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$1,875,000
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Cost of goods sold
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1,310,000
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Gross margin
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565,000
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Selling and admin. expense
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217,500
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Amortization
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48,200
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Lease Payments
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39,000
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Operating earnings (EBIT)
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260,300
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Interest expense
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85,000
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Earnings before taxes
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175,300
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Taxes
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55,300
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NIAT
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$ 120,000
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Millipore CorpBalance Sheet
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ProForma
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Assets
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2004
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2005
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Cash
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$ 60,000
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Accounts receivable
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360,000
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Inventory
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290,000
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Total current assets
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710,000
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Net plant and equipment
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1,390,000
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Total assets
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$2,100,000
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Liabilities and Owners' Equity
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Accounts payable
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$ 460,000
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Accruals
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35,000
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Line of Credit
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45,000
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Total current liabilities
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540,000
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Long-term debt
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703,900
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Common shares
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340,000
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Retained earnings
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516,100
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Total liabilities and equity
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$2,100,000
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2. Fine Foods Catering Ltd (FFC) operates a serving-line cafeteria in an office building in downtown Halifax, Nova Scotia. About 1,500 people work in the office building. The cafeteria is open 250 days a year and operates from 7:00 am until 4:00 pm. Demand always peaks during the lunch hours. For lunch, 600 people want to use the cafeteria, however, the serving-line facilities can only accommodate 400 people. Therefore, each day 200 potential customers are turned away. The owners of FFC have recently recognized that this is resulting in a considerable loss of revenue for the cafeteria.
To tap the excess demand, the cafeteria is considering expanding the current serving-line facilities over the upcoming Christmas holidays. Expanding the serving-line will cost $260,000. With the expansion, it is estimated that 75% of the customers that are currently being turned away from the cafeteria will use the cafeteria.
For the cafeteria, the current average lunch sale is $5.40 excluding taxes. The direct cost of the average lunch (the food sold) is 40%. This will remain the same if the serving-line facilities are expanded. With the expanded serving-line, an extra cook, dish washer, and cash clerk will be required. The wages for these new employees will be $28,000, $12,500, and $21,500 per year, respectively. In addition, extra cleaning costs of $45 per day will be incurred.
Since sales will increase with the expanded serving-line, the cafeteria will have to invest an additional $0.10 in food inventory for each $1.00 increase in sales. The serving line expansion has an expected useful life of 20 years. The salvage value of the new equipment at the end of its 20 year life will be $25,000 and it will cost $2,500 to dismantle. The CCA rate for the new serving-line facilities is 15%. FFC's tax rate is 20% while their cost of capital is 14%.
Required:
a) Should FFC expand the current serving-line facilities in the cafeteria? Fully explain being sure to provide a complete net present value analysis.
b) For the following question, additional calculations are not required. If the firm's cost of capital were 12.5% and not the 14% used above, would this change your answer? Briefly discuss.
Remember, do not make any calculations.
3. It is January 2, 2005 and the President of Byfield Corporation has approached you with a problem. The president has uncovered three possible independent projects that the company could invest in. The president is wondering which of the projects the company should select. You inform the President, based on the knowledge gained in your corporate finance course, that she must first determine the company's cost of capital.
Based on this response, the President hires you to complete the analysis. You know that after calculating the company's cost of capital, you can make a decision regarding the available projects.
Byfield's capital structure, which is considered optimal, is as follows:
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Bonds (10% coupon, due December 6, 2005)
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$ 3,800,000
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Preferred equity ($20 stated value, 8.1% dividend rate)
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1,400,000
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Common shares (972,152 common shares outstanding)
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1,000,000
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Retained earnings
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3,800,000
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Total Capital
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$10,000,000
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If Byfield were to issue a bond, it would have a life of 25 years. Byfield's current bonds were issued in 1985 for $998.25 per $1,000 of par. The bonds are now rated BBB (low) and are currently trading for $1,011.61 per $1,000 of par. Magna Canada, also rated BBB (low), has a bond outstanding that has 20 years to run to maturity and has a coupon rate of 11% (paid semi-annually) This bond is currently trading for $1,238.47.
Byfield's underwriter has informed the company that for a bond with a 25 year maturity, the market would require a premium 30 basis points (0.30%) more than that provided on a 20 year bond issue with the same default risk. The new bond would be sold for $1,002 and issue costs on a new bond issue would be 2.2% of par. Byfield's tax rate is 20%.
Byfield's preferred shares are currently trading for $18.10. If Byfield issued new preferred shares, their underwriter has suggested that issue costs would be 2.7% of the $25 stated value of the new issue.
Byfield's most recent earnings available to common shareholders were $1,905,418 and the company paid common share dividends of $369,418 or $0.38 per share. Byfield's common shares are currently trading for $12.22 per share. You have been told that the company's earnings and dividends are expected to grow by 16% per year for the foreseeable future. For a sale of new common shares, issue costs would be 4.83% of the current share price.
The costs and the expected returns of the three projects Byfield is considering are presented below.
Expected
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Project
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Cost
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Return
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Laser-based imaging machine
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$1,000,000
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13.4%
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Thermal transfer colour printer
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$3,000,000
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18.8%
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Industrial application imaging machine
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$5,500,000
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15.9%
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Required:
a) Calculate Byfield's cost of capital. Which project(s) should Byfield accept? Explain.
b) In the phrase "cost of capital," what has a cost? Briefly explain why knowing the cost of capital is important for a company.