Part 1: Capital Budgeting Analysis Adams, Inc Would ✓ Solved

Part 1: Capital Budgeting Analysis Adams, Incorporated would

Part 1: Capital Budgeting Analysis Adams, Incorporated would like to add a new line of business to its existing retail business. The new line of business will be the manufacturing and distribution of animal feeds. This is a major capital project. Adams, Incorporated is aware you are in an MBA program and would like you to help analyze the viability of this major business venture based on the following information: The production line would be set up in an empty lot the company owns. The machinery’s invoice price would be approximately $200,000, another $10,000 in shipping charges would be required, and it would cost an additional $30,000 to install the equipment. The machinery has a useful life of 4 years, and it is a MACRS 3-year asset. The machinery is expected to have a salvage value of $25,000 after 4 years of use. This new line of business will generate incremental sales of 1,250 units per year for 4 years at an incremental cost of $100 per unit in the first year, excluding depreciation. Each unit can be sold for $200 in the first year. The sales price and cost are expected to increase by 3% per year due to inflation. Net working capital would have to increase by an amount equal to 12% of sales revenues. The firm’s tax rate is 40%, and its overall weighted average cost of capital is 10%.

Required: 1. If the company spent $40,000 last year in the upkeep of the empty lot, should this cost be included in the analysis? Why or why not? 2. Disregard the assumptions in part 1 above. What is the machinery’s depreciable basis? What are the annual depreciation expenses? 3. Calculate the annual sales revenues and costs (other than depreciation). 4. Construct annual incremental operating cash flow statements. 5. Estimate the required net working capital for each year based on sales for the following year. Working capital will be recovered at the end of year 4. 6. Calculate the after-tax salvage cash flow. 7. Calculate the net cash flows for each year. Based on these cash flows, what are the project’s NPV, IRR, Profitability Index (PI), and payback? 8. Can you use the Payback method to decide whether this is a good project or not? Why or why not? 9. Interpret what NPV, IRR, and Profitability Index (PI) mean. Based on your interpretation, do these indicators suggest the new business line should be undertaken?

Part 2: Working Capital Management 1. Adams Stores, Inc. is trying to determine the effect of its inventory turnover ratio and days sales outstanding (DSO) on its cash flow cycle. Adams’ sales last year (all on credit) were $150,000, and it earned a net profit of 6%. It turned over inventory 7.5 times during the year and its DSO was 36.5 days. Its annual cost of goods sold was $121,667. The company had fixed assets totaling $35,000. Adams’ payable deferral period is 40 days. A. Calculate Adams’ cash conversion cycle B. Calculate assets turnover and return on assets (ROA) C. As one of the managers at Adams Stores, Inc, you believe the annual inventory turnover can be raised to 9 times without affecting sales. What would Adams’ cash conversion cycle, total assets turnover, and ROA have been if the inventory turnover had been 9 for the year? 2. Assume the company work for reported sales of $10 million and an inventory turnover of 2. The company is now adopting a new inventory system as part of its working capital management. If the new system is able to reduce the company’s inventory level and increase inventory turnover ratio to 5 while maintaining the same level of sales, how much cash will be freed up as a result of the new inventory system.

Part 3: Dividend Policy: Assume that you were recently hired by a national consulting firm, which has been asked to help Adams, Stores, Inc. prepare for its public offering. Prepare a presentation in which you review the theory of dividend policy and discuss the following: A. The terms “irrelevance,” “bird-in-the-hand,” and “tax preference” have been used to describe three major theories regarding the way dividend payouts affect a firm’s value. Explain what these terms mean, and briefly describe each theory. B. What do the three theories indicate regarding the actions management should take with respect to dividend payouts? C. What are stock repurchases? Discuss the advantages and disadvantages of a firm’s repurchasing its own shares. D. What are stock dividends and stock splits? What are the advantages and disadvantages of stock dividends and stock splits?

Part 4: International Financial Management Citrus, Inc. is a medium-sized producer of citrus juice drinks in Florida. Until now, the company has confined its operations and sales to the United States, but its CEO, Heidi Sims, wants to expand into Europe. The first step would be to set up sales subsidiaries in Spain and Sweden, then to set up a production plant in Spain, and, finally, to distribute the product throughout the European Union. The firm’s financial manager, George Benson, is enthusiastic about the plan, but he is worried about the implications of the foreign expansion on the firm’s financial management process. He has asked you, the firm’s most recently hired financial analyst, to develop a 1-hour tutorial package that explains the basics of multinational financial management. The tutorial will be presented at the next board of director’s meeting. To get you started, Benson has supplied you with the following list of questions. A. What is a multinational corporation? Why do firms expand into other countries? B. Discuss at least six major factors which distinguish multinational financial management from financial management as practiced by a purely domestic firm. (Please consider doing additional research on this question and document your findings). C. Discuss exchange rate risk as they relate to multinational corporations. D. Describe the current International Monetary System. How does the current system differ from the system that was in place prior to August 1971? (Please consider doing additional research on this question and document your findings). E. What is the difference between spot rates and forward rates? When is the forward rate at a premium to the spot rate? At a discount? (Please consider doing additional research on this question and document your findings). F. From a managerial point of view, discuss how your responses above will help Citrus, Inc. as they plan to expand overseas.

Specific Instructions: 1. Complete and submit your assignment no later than the last day of Module 7. 2. Include only the names of your group members who participated in this assignment when you submit. 3. Submit only one copy per group. 4. If you use Excel for any of your calculations, please submit the Excel worksheet. Be sure to label your Excel worksheet appropriately. Use Word for your discussions. Please DO NOT use any other format such as PDF, etc. Use APA throughout including in-text citations and references. 5. After you complete the assignment, please give each member opportunity to review the final paper before you submit it. You are jointly responsible for any error made. Side Note: Please note that this is not the type of assignment where the assignment is divided and each student completes the part that is assigned. Each person in your group needs to participate fully in the completion of this assignment. This is the only way each group member can master and be able to use the concepts in this assignment. After you complete the assignment, please give each member opportunity to review the final paper before you submit it. You are jointly responsible for any error made.

Paper For Above Instructions

Capital budgeting analysis is essential for organizations considering major projects, such as Adams, Incorporated's intent to add a new line of business focused on manufacturing and distributing animal feeds. This analysis will encompass various components, including initial capital expenses, operational revenues, and the resulting cash flows associated with the project.

1. Inclusion of Upkeep Cost: The $40,000 spent on the upkeep of the empty lot from the previous year should not be included in the capital budgeting analysis. This cost is considered a sunk cost, having already been incurred and irrelevant to the future cash flows associated with the project.

2. Depreciable Basis and Depreciation Expenses: For the new machinery, the depreciable basis includes the invoice price of the machinery ($200,000), shipping costs ($10,000), and installation costs ($30,000), leading to a total depreciable basis of $240,000. As it falls under a MACRS 3-year property, the depreciation rates are generally approximated to 33.33% for the first year, 44.45% for the second, and 14.81% for the third year, concluding with a 7.22% salvage value in the fourth year. The corresponding annual depreciation expenses would be as follows: Year 1: $80,000, Year 2: $106,668, Year 3: $35,784, and Year 4: $17,280.

3. Annual Sales Revenues and Costs: The initial sales price of each unit is $200, with a projected annual inflation increase of 3%. Therefore, annual sales revenues in Year 1 can be computed as 1,250 units × $200, translating to $250,000. Incremental costs per unit begin at $100, giving total costs of $125,000 in Year 1. Future revenues and costs will increase proportionally according to the explained inflation rate, paralleling the expected price changes.

4. Annual Incremental Operating Cash Flow Statements: The crucial operating cash flow calculation must take into account sales revenues, incremental costs excluding depreciation, and tax implications. By calculating after-tax cash flows and adding back non-cash expenses like depreciation, the firm can ascertain the net cash flow annually.

5. Required Net Working Capital: The increase in net working capital as 12% of future sales would necessitate calculation for each operating year based on predicted sales figures. For instance, Year 1 would reflect $30,000, which will vanquish through the lifecycle of the project, reclaiming the working capital in Year 4.

6. After-Tax Salvage Cash Flow: To calculate the after-tax salvage cash flow, one must determine the potential taxable gain on selling machinery at the end of Year 4. With a salvage value of $25,000 and considering depreciation implications, the estimated after-tax salvage flow reflects in the final cash flow statement.

7. Net Cash Flows and Project Evaluation: The net cash flow for each year will be derived by taking operational cash flows from aforementioned computations while factoring in depreciation, salvage values, and working capital changes. Using these net cash flows, one can compute the project’s Net Present Value (NPV), Internal Rate of Return (IRR), Profitability Index (PI), and Payback period, providing a comprehensive financial overview of the potential investment.

8. Payback Method Utilization: While the Payback method offers a simplistically appealing way to analyze capital projects, it has drawbacks, such as ignoring cash flows beyond the payback period and time value of money. Thus, it might not adequately convey the comprehensive value of the project.

9. Interpretation of Financial Indicators: The NPV, IRR, and PI represent crucial financial metrics. A positive NPV suggests that the project will generate more wealth for shareholders, while an IRR exceeding the cost of capital signifies a worthwhile investment. The Profitability Index provides insights into the relative profitability of the project. Ultimately, if these metrics signal a favorable outcome, the proposal to undertake this new business line should be strongly considered.

Part 2 dives into working capital management strategies relevant to Adams Stores, Inc., wherein inventory turnover ratios and DSO critically affect cash flow cycles. For example, by analyzing annual operational statistics, critical ratios can be calculated: cash conversion cycle, total asset turnover, and ROA enhance strategic financial decision-making.

In Part 3, dividend policy discussions emphasize theories such as “irrelevance,” “bird-in-the-hand,” and “tax preference,” illustrating how these frameworks impact decision-making around dividend payouts and shareholder value. Understanding stock repurchases, stock dividends, and stock splits equips management to navigate funding and investor relations effectively.

Lastly, Part 4 addresses the challenges and opportunities presented within the realm of international financial management. A comprehensive tutorial on these concepts will arm Citrus, Inc. with knowledge essential for successful expansion into European markets, solidifying its global footprint.

References

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