Corporate Finance Case Studies

ATHENS UNIVERSITY OF ECONOMICS & BUSINESS STUDIES EXECUTIVE MBA

Coursework for the “Financial Management” Module Problem 1 MotorVehicle S.A. is thinking of launching an electric car in the European market. The electric car was expected to produce sales of €10 million in the first year and €13 million in the second year. The intense industry competition and price erosion will affect the sales of the electric car, which are expected for the 2 nd and 3rd year following introduction to remain unchanged. In the 4th and 5th year MotorVehicle S.A. expects annual sales of the electric car to fall to two-thirds and one-third of peak annual sales respectively. After the 5th year the company is not expecting any sales, costs or expenses associated with the new electric car. The cost of sales for the new electric car was expected to reach 60% of total annual sales during each year of its life cycle. Selling and general expenses were expected to be 23.5% of total annual sales and the profit tax rate would be 40%. The launching of the new electric car would require an investment of €500,000 immediately, in new specialized production line, to ensure that the facilities at MotorVehicle S.A. are among the most modern in the country. This outlay would be fully depreciated on a straight-line basis over the five-year life cycle of the electric car and it is not expected to have any material salvage value at the end of its depreciable life. Furthermore, MotorVehicle S.A. would have to incur an increase in net working capital in order to support sales. The company generally required 27 cents of net working capital to support each euro of sales. In order to ensure the smooth running of the investment project the new working capital buildup would have to be made by the end of the previous year. It should be stressed that as sales grew, further investments in the working capital ahead of sales would have to be made, whereas, as sales diminished, net working capital would be liquidated and cash recovered. At the end of the electric car’s life cycle, all remaining net working capital would be liquidated and the cash recovered. MotorVehicle S.A. expected, only in the first year of the new electric car sales, to incur introductory expenses of €200,000, which are tax-deductible. During the development stage of the new electric car, €1 million had already been spent. These investments in research and development were also one-time expenses that would not be recurring during the new products life cycle. a.

Calculate the product’s cash flows throughout its five-year life cycle (Assume rounding and no decimal points). b. What is the product’s net present value at 20% discount rate? (Assume rounding and no decimal points). c. What is the product’s internal rate of return? (Assume two decimal points). d. Should company A introduce the new product? (45 marks)

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Problem 2 The market price of company’s B stock is €100 per share and the company has 10,000 shares of common stock outstanding. The company does not have any debt; therefore, the market value balance sheet of the company appears as follows: Assets

€1,000,000

Company B Balance Sheet Equity

€1,000,000

Company B faces a new investment opportunity in a new project that will have positive net cash flows with a present value of €210,000. Total initial cost for investing and developing this project are only €110,000. Company B is considering raising the necessary capital for this investment by issuing new equity. All potential new shareholders will be fully aware of the project’s value and cost, and are willing to pay fair value for the new common shares. a. What is the net present value of this project? b. How many shares of common stock must be issued, and at what price, to raise the required capital? c. What is the effect, in any, of this new project on the value of the stock of the existing shareholders? (25 marks) Problem 3 Company C is closing down a factory and firing all its workers. The company must continue to pay for workers’ health for 4 years. The health cost per worker next year will be €2,000, but the inflation rate is 5 percent, and health cost have been increasing at 3 percentage points faster than inflation rate. The nominal discount factor is 10 percent. What is the present value of this obligation? (Assume rounding and no decimal points) (10 marks) Problem 4 Company D is considering an investment that offers a net cash flow of €100,000 per year for indefinite future. The risk of this project is felt to be the same as the average for all stocks. If the Treasury bill yield is 8 percent and the market returns is expected to be 14 percent, what is the maximum investment outlay that should be made? (Assume rounding and no decimal points) (10 marks) Notes:  The deadline for of the assignment is 13th of June 2014.  All answers should be sent to my email in a single Word file. The file of your assignment should be named as follows: Surname-Initial. For example, if your name is Peter Drucker, then you should name your file as: Drucker-P.  If you need any further clarifications my e-mail is [email protected] and my office

phone number +30 210 4142200.

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