Choose a publicly traded company and analyze its financial ratios, capital structure, cost of capital and do a capital budgeting for your chosen company. (See below)
*** My company I choose is IBM Corporation.
1. Purpose of the project:
In this project, you are supposed to be a financial manager working for a big corporation and you have to apply the knowledge obtained from the financial management (FIN6352) course to determine the cost of debt, cost of preferred stock, cost of common equity, capital structure, and the weighted average cost of capital (WACC) for a publicly-traded company of your choice. You will use the WACC as the discount rate to conduct capital budgeting analysis for a project that the firm is considering and then decide whether it should be accepted or not.
2. Outline for the project:
(1) Executive Summary (10 points)
– Summarize the results and analysis of the report.
(2) Financial Ratio Analysis (40 points)
You are supposed to be a financial analyst covering a firm in particular. You are expected to apply the knowledge obtained in this course and determine the firm’s strengths and weaknesses relative to its peers and to describe historical growth of key variables.
– Perform trend analysis of the key financial ratios (i.e., liquidity ratios (2 ratios), asset management ratios (3), debt management ratios (3), profitability ratios (4 most important), market value ratios (4 ratios) of the company.
– Perform industry (or benchmark companies) comparison analysis of the key financial ratios of the company.
– Based on the financial ratio analysis results, evaluate the financial performance of the company.
(3) Estimate Capital Structure (25 points)
– Estimate the firm’s weights of debt, preferred stock (If any), and common stock using the firm’s balance sheet (book value).
– Estimate the firm’s weights of debt, preferred stock (If any), and common stock using the market value of each capital component.
(4) Compute Weighted Average Cost of Capital (WACC) (35 points)
– Estimate the firm’s before-tax and after-tax component cost of debt; (Note: Use 21 % tax rate for your chosen corporation).
– Estimate the firm’s component cost of preferred stock if the company uses preferred stocks in its capital structure;
– Use three approaches (CAPM, DCF, bond-yield-plus-risk-premium) to estimate the component cost of common equity of the firm. Then assign a weight for each method and estimate weighted average cost of equity. Using this average:
– Calculate the firm’s weighted average cost of capital (WACC) using market-based capital weights.
– Calculate the firm’s weighted average cost of capital (WACC) using book-based capital weights.
– Calculate the firm’s weighted average cost of capital (WACC) using optimal capital structure weights.
(5) Cash Flow Estimation (40 points)
– We assume that the company you selected is considering a new project. The project has 8 years’ life. This project requires initial investment of $235 million to purchase the building, and purchase equipment, and $15 million for shipping & installation fee. The fixed assets (Total of 235+15= $250 M) fall in the 7-year MACRS class. The salvage value of fixed assets is $38 million. The number of units of the new product expected to be sold in the first year is 900,000 and expected to grow at annual growth rate of 9%. The sales price is $265 per unit and the variable cost is $174 per unit in the first year, but they should be adjusted accordingly based on the estimated annualized inflation rate of 2.8%. The
required net operating working capital (NOWC) for each year is 15% of sales for that year. The company is in the 21% tax bracket. The company’s optimal capital structure is 65% equity and 35 debt financing. Assume a WACC of 7 % based on target capital structure of this firm. (This WACC probably is different than your estimates above).
– Compute the depreciation basis and annual depreciation of the new project. (Please refer to table of 11A-2, page 496 for 16th edition).
– Estimate annual net cash flows of the project for all the 8 years.
– Draw a timeline of the cash flows.
(6) Capital Budgeting Analysis (40 points)
– Which WACC should you use for this project evaluation?
– Using your best choice above, apply various methods of project evaluation (NPV, IRR, MIRR, PI, Payback, Discounted Payback) to analyze the new project. Should it be accepted or rejected?
– Perform a sensitivity analysis for the effects of key variables (e.g., , cost of capital, unit costs, sales price) on the estimated NPV in order to demonstrate the sensitivity of the model. The Scenario analysis of several variables simultaneously is encouraged, but not required.
– Discuss whether the project should be taken and summarize your report.
3. Other information regarding the project:
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(3) Your project should be well-organized and typed in a Word document and attach the necessary Excel worksheets with your report, the Excel file should support the data in your Word file. The style and organization of the project account for 10 points.
