AFM373 Lecture Notes - Lecture 9: Income Statement, Promissory Note, Private Equity

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lilacmouse857

3 Jul 2018

School

University of Waterloo

Department

Accounting & Financial Management

Course

AFM373

Professor

Neil Brisley

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Flash Case

Roles, issues, alternatives

1.Invest or not invest

2.How to finance? With or without equity

Right now Flash can factor A/R to the bank to get more borrowing but its more expansive with higher

interest payments.

Analysis

The market is competitive and Flash needs to continually invest in R&D. Any new products invented

have a short life.

If issue equity? Who's willing to invest in Flash and put in a few million dollars?

Flash is a private company and so shares are not available to everyone.

oVenture capitalist

oPrivate equity

oMaybe financial institutions

Projected financial statements

Rapid sales growth requires more financing because:

Sales growth drives asset growth (if days are kept the same)

If ROE (growth of equity) doesn't keep up with sales growth, then we need more financing.

However, in Flash, the days of current assets are getting worse (too many days in inventory =

more inefficiency) which requires a funding need.

Looking at the next three years forecast, it is definitely generating a funding need because sales growth

is way ahead of ROE.

New project: NPV of free cashflows to the firm

400k is sunk cost not included in FCFF

For R&D what do we put?

There's a 5% of sales spent on R&D. if it was spent on this project then we'll count it. If it wasn't

spent on this project, then we don't.

Remember to add back decrease in working capital when the project is closed in year 6

Depreciation adjustment and changes in NWC adjustment is decreasing our NPV when calculation FCFF

Although they net to 0 over the periods, most of the outflows are early in the years and inflows

are late in the years and time value makes the inflows more worthless than early outflows.

If you do a NPV of EBIT(1-t), its higher than the NPV of cash flows because it doesn't include the

depreciation/NWC adjustments

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Document Summary

Right now flash can factor a/r to the bank to get more borrowing but its more expansive with higher interest payments. The market is competitive and flash needs to continually invest in r&d. Any new products invented have a short life. Flash is a private company and so shares are not available to everyone: venture capitalist o. Sales growth drives asset growth (if days are kept the same) If roe (growth of equity) doesn"t keep up with sales growth, then we need more financing. However, in flash, the days of current assets are getting worse (too many days in inventory = more inefficiency) which requires a funding need. Looking at the next three years forecast, it is definitely generating a funding need because sales growth is way ahead of roe. New project: npv of free cashflows to the firm. 400k is sunk cost not included in fcff.

Related Questions

Garnett Jackson, the founder and CEO of Tech Tune-Ups, stared t the window as he finished his customary peanut butter and jelly dwich, contemplating the dilemma currently facing his firm. ech Tune-Ups is a start-up firm, offering a wide range of com- ter services to its clients, including online technical assistance, ote maintenance and backup of client computers through the temet, and virus prevention and recovery. The firm has been 'ghly successful in the 2 years since it was founded; its reputation fair pricing and good service is spreading, and Mr. Jackson lieves the firm is in a good position to expand its customer base idly. But he is not sure that the firm has the financing in place to rt that rapid growth. Tech Tune-Ups' main capital investments are its own powerful mputers, and its major operating expense is salary for its consul- ts. To a reasonably good approximation, both of these factors w in proportion to the number of clients the firm serves. Currently, the firm is a privately held corporation. Mr. Jackson his partners, two classmates from his undergraduate days, have tributed $250,000 in equity capital, largely raised from their nts and other family members. The firm has a line of credit a bank that allows it to borrow up to $400,000 at an interest of 8%. So far, the firm has used $200,000 of its credit line. If when the firm reaches its borrowing limit, it will need to raise ity capital and will probably seek funding from a venture capi- firm. The firm is growing rapidly, requiring continual invest- t in additional computers, and Mr. Jackson is concerned that it approaching its borrowing limit faster than anticipated. 525 Mr. Jackson thumbs through past financial statements and esti- mates that each of the firm's computers, costing $10,000, can sup- port revenues of $80,000 per year but that the salary and benefits paid to each consultant using one of the computers is $70,000. Sales revenue in 2011 was $1.2 million, and sales are expected to grow at a 20% annual rate in the next few years. The firm pays taxes at a rate of 35%. Its customers pay their bills with an average delay of 3 months, so accounts receivable at any time are usually around 25% of that year's sales. Mr. Jackson and his co-owners receive minimal formal salary from the firm, instead taking 70% of profits as a "dividend," which accounts for a substantial portion of their personal incomes. The remainder of the profits are reinvested in the firm. If reinvested profits are not suffi- cient to support new purchases of computers, the firm borrows the required additional funds using its line of credit with the bank. Mr. Jackson doesn't think Tech Tune-Ups can raise venture funding until after 2013. He decides to develop a financial plan to determine whether the firm can sustain its growth plans using its line of credit and reinvested earnings until then. If not, he and his partners will have to consider scaling back their hoped-for rate of growth, negotiate with their bankers to increase the line of credit, or consider taking a smaller share of profits out of the firm until further financing can be arranged. Mr. Jackson wiped the last piece of jelly from the keyboard and settled down to work. Can you help Mr. Jackson develop a financial plan? Do you think his growth plan is feasible? Prepare a 700-1,050 word response, plus Excel spreadsheet, for the Mini-case at the end of Chapter 18 in Fundamentals of Corporate Finance (Brealey). Specifically, the Learning Team will need to follow all assumptions in the Mini-case precisely and carefully to complete the following: a. Identify the steps necessary to financially plan and forecast for 2005, 2006, and 2007, b. Project future years using the growth rate assumptions in the Mini-case, c. Determine what type and amount of financing may be required, taking into account the impact on leverage ratios, d. Determine the impact of rising interest rates on future performance, e. Assess alternative capital structures and impact on debt ratio and return on equity. f. Separately, after completing (a) through (e) above, explain how outsourcing certain cost of goods sold items would impact this planning and budgeting process.

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AFM373 Lecture Notes - Lecture 9: Income Statement, Promissory Note, Private Equity

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