FIN 620 UMD Long term Financial Management ACME Iron Executive Summary Capstone This week we will continue our discussion of financial issues. Please continue contributing to and participating in the discussions. Below is a complete description of the Final individual Paper.

Course Deliverable: Review the scenarios 1 through 9. Assemble a report responding to the tasks you have been given by the Controller. Structure your report so it is clear which task you are addressing. Summarize the results of each task in the body of your report and refer to the detailed supporting calculations contained in your excel work sheet.

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Frequently Asked Questions:

· How long should my paper be in terms of pages?

Since this is a comprehensive report to management it should be summarized with an executive summary, contain details on each scenario analysis with supporting calculations. Expectations should be 10-12 pages including cover page, executive summary and references. You should also include an Excel sheet with all detailed calculations with each problem clearly titled and references to any templates or material from other sources.

· Who is the audience for my paper?

This is a report which will go to your immediate supervisor and Acme’s senior management. As you are preparing your report ask yourself “is the information that I am including important and relevant to my supervisor and senior management?”

Rubric:

Learning Competency

Highly Proficient

Proficient

Low/No Proficiency

90 – 100

70 – 89

0 – 69

1 Communication: Learners demonstrate ability to communicate clearly both orally and in writing.

2 Critical Thinking: Learners demonstrate ability to apply logical, step-by-step decision-making processes to formulate clear, defensible ideas and to draw ethical conclusions.

3 Quantitative Reasoning: Learners demonstrate the ability to use mathematical operations and analytical concepts and operations to address problems and to inform decision-making.

4 Financial Management Knowledge: Learners will demonstrate applied understanding of financial management concepts as used in the professions.

5 Integrated Thinking and Application: Apply knowledge of accounting and financial management in an integrated way to solve problems faced by individuals and organizations.

6 Data/Information Analysis: Learners gather and analyze data and information for information sharing, problem solving, decision making and other purposes. GROUP PROJECT TASK 1

CAPM

FEBRUARY 16, 2020

AYOADE ADEMILUYI, FLORENCE AKADJE, TANJA DETWILER, ANTHONY GECKELER, DESIREE

PORQUET, JAY STEVENS

UMGC

Task 1 with Financials

Introduction: As a special analytical group set up by ACME Iron by the firms Controller, you

have been tasked to respond to the following issues raised in a meeting with the CFO. You and

your team must look over several prospective financial strategies to aid in the successful growth

of ACME Iron.

You are to work over an 10 week period on several projects, detail your work as you proceed on

these projects, and assemble the report for the CFO to make to the board on the items listed

while you work in a team environment. Management will be looking at the team over this period

on how well they self-organize and analyze the research areas which will include:

·

Capital investment analysis

·

CAPM Capital Asset Pricing Model determination for the company

·

WACC Weighted Average Cost of Capital computations

·

EVA Economic Value Analysis

·

MVA Market Value Added

·

Capital structure of the company

·

Dividend policy

·

Stock repurchase and option pricing strategy

·

Bankruptcy risk analysis

·

Decision Tree Creation

·

Real option analysis of projects

The CFO wants to test your team out on a simple project in the first task before you get into

preparing items for his board presentation in subsequent tasks and projects. He wants to see

how well you perform tasks as a team as well as how accurate and thoughtful you are in your

work. Details are important to him as well as good organization/presentation and

communication.

Financial Statements for use on Tasks

Here are the financial statements you are to use in this exercise:

Balance

Sheet

ACME Iron

Assets

Current assets:

2014

2015

change

100,

Cash

500,000

600,000

1,000,000

1,025,000

110,000,000

117,000,000

000

25,0

Investments

00

7,00

Inventories

0,000

750,

Accounts receivable

Pre-paid expenses

11,750,000

12,500,000

2,500,000

2,600,000

000

100,

000

Other

0

0

125,750,000

133,725,000

–

7,97

Total current assets

Fixed assets:

2014

2015

5,000

change

10,0

Property and equipment

180,000,000

190,500,000

0

0

55,000,000

65,000,000

Leasehold improvements

00,000

–

10,0

Equity and other investments

00,000

20,0

Total fixed assets

Other assets:

235,000,000

2014

255,500,000

2015

00,000

change

(5,00

Goodwill

70,000,000

0,000)

75,000,000

70,000,000

(5,0

00,000)

435,750,000

459,225,000

Current liabilities:

2014

2015

Accounts payable

40,500,000

42,400,000

0,000

Accrued wages

85,000,000

90,500,000

0,000

Total other assets

75,000,000

23,4

Total assets

75,000

Liabilities and owner’s equity

change

1,90

5,50

855,

Accrued compensation

10,000,000

10,855,000

000

673,

Income taxes payable

4,024,000

4,697,000

current portion of LT debt

5,500,000

10,350,000

0

0

145,024,000

158,802,000

000

4,85

Other

Total current liabilities

Long-term liabilities:

2014

2015

0,000

–

13,778,000

change

5,00

Long term debt

125,000,000

130,000,000

0,000

Total long-term liabilities

125,000,000

130,000,000

0,000

5,00

Owner’s equity:

Common stock

2014

122,000,000

2015

122,000,000

change

–

Preferred stock

16,725,000

16,725,000

–

Accumulated retained earnings

27,001,000

31,698,000

7,000

165,726,000

170,423,000

7,000

435,750,000

459,225,000

4,69

4,69

Total owner’s equity

Total liabilities and owner’s

equity

23,4

75,000

Task 1

Reach out to team members and assign roles. You all need to contribute. Rotating

responsibilities is a suggested strategy in this team environment.

Capital Asset Pricing Model (CAPM):

Your team needs to investigate certain items to compute the required rate of return of your

company. The expected market return for the coming year is 6%, you need to find the current

rates for the 10 year Treasury bond to establish a risk-free rate. Please remember to cite your

source of this data and justify your reasoning for using this source or data.

Your team will also need to find a rationale for estimating beta since you do not have a long

history on the stock market since you are recently listed. You realize that ACME Iron is capital

intensive so the beta for the company will be influenced by this point. Since ACME Iron is an

iron producer its beta should be in line with similar companies. Your team will need to analyze

other companies or this industry to come up with a beta calculation for ACME Iron. Please

document your investigation, sources and justify your choice of beta for Acme.

Concept Check: The Capital Asset Pricing Model is a model that separates market risk from individual

asset risk. We look at Market risk through the lens of inflationary impact on asset returns and the

opportunity cost of the risk free rate. Market risk effects all assets so we utilize Beta as a measure of the

volatility of price changes in the particular asset we are analyzing versus the market of that particular

asset class.

Helpful Hint: Discuss strategy of finding financial resources with your team. Sources should be

current and dependable. Government resources are usually the best since they are free of charges

and free of bias.

Answer:

The Capital Asset Pricing Model (CAPM) describes the relationship between a stocks expected

rate of return and its risk. A higher expected rate of return comes with a higher risk for the

investor. The formula for CAPM is the risk-free rate of return plus a risk premium for the higher

rate of return (corporatefinanceinstitute.com, 2020).

The formula for CAPM is:

Rs = Rf + b * (Rm – Rf)

For ACME Iron the numbers are

Rs = 0.0159 +1.62 * (0.06-0.0159)

Rf = 0.0159 (Treasury.org, 02.14.2020). The risk-free rate is equal to the 10-year Treasury bond

rate. The rate for the 10-year treasury bond is taken directly from the Treasury web site, a

Government website. 0.0159 was the latest rate on February 14, 2020.

Rm= 0.06

B = 1.62 (stern.nyu.edu, 02.16.2020) To calculate the beta, we will need to look at the steel

industry average beta, which is 1.62 per the beta by section website. Data is as of January 2020

for industries in the US with the number of firms included. Beta can be calculated in other ways

but ACME company does not have a stock rate of return and does not have a long trading history

so we use the average beta. A further Internet search for the average beta of steel companies

confirmed the beta of 1.62 (Lippincott Library, 2018 and Stanford University, NA).

A beta of 1 means that the stock price moves with the market. A beta less than 1 means that the

stock price is less volatile than the market; and a beta of more than 1 means that the stock price is

more volatile than the market. ACME Iron stocks beta is more than 1; and, thus, is more volatile

than the market (corporatefinanceinstitute.com, 2020).

When pulling into the formula the return is below:

Rs = Rf + b (Rm – Rf) = 1.59 + 1.62 * (6.00-1.59)

1.59 + 1.62 * 4.41

1.59 + 7.14

= 8.73% rate of return

ACME Iron is very capital intensive. Its capital is greatly funded with debt. The debt to equity

ratio is 169% (288,802/170,423). This makes ACME Iron a risky investment and justifies the

higher-than-market beta.

References

Corporatefinanceinstitute.com. (2020). Capita Asset Pricing Model (CAPM). Retrieved from

https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-capmformula/

Lippincott Library. (2018, January 25). Where can I find the current and historical betas?

Retrieved from https://faq.library.upenn.edu/business/faq/45560

Stanford University. (NA). Where can I find current and historical betas for companies and/or

industries. Retrieved from https://businessfaq.stanford.edu/where-can-i-find-current-andhistorical-betas-companies-andor-industries

Stern.nyu.edu. (2020). Betas by sector (US). Retrieved from

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/Betas.html

Treasury.gov. (2020, February 14). Daily Treasury yield curve rates. Retrieved from

https://www.treasury.gov/resource-center/data-chart-center/interestrates/pages/TextView.aspx?data=yieldYear&year=2020

Task 2

How do we compute the WACC in this circumstance?

The WACC (weighted average cost of capital) is simply a companys cost of capital in

which each category of capital ends up being proportionately weighted (Ramtohul, 2016). In the

case of ACME iron, the WACC will be determined by computing the proportions of debt and

equity of the firm, the after tax cost of debt and the cost of equity

After-tax cost of debt =Before-tax cost of debt x (100% – incremental tax rate) = 8 %*(

100%-40%) = 4.80%

Cost of equity=Risk Free Rate + Beta Coefficient × Market Risk Premium= 8%

Acmes Proportions of debt (w d) for 2015 = debt/ (debt +equity) = (10,350,000 +

130,000,000) / (122,000,000 + 16,725,000 +31,698,000 + 10,350,000 + 130,000,000) =

140,350,000 / 310,773,000 = 0.45161= 45.16%

Acmes Proportion of equity (We) for 2015= (122,000,000 + 16,725,000 + 31,698,000) /

(122,000,000 + 16,725,000 + 31,698,000 + 10,350,000 + 130,000,000) = 170,423,000 /

310,773,000 = 0.54838 = 54.84%

Therefore, ACME irons WACC, which is calculated using the following formula = W e*

Cost of equity (Re) + W d *After-tax cost of debt (Rd*(1 T) w) will be equal to=

0.54838*0.08+ 0.45161*0.048 = 0.065548 or 6.55%

Why do we need to be concerned with the WACC?

Firstly we need to be concerned with the WACC because it is needed when calculating

NPVs of projects to discount the future cash flows of the projects to the present value. Therefore

the higher the WACC the lower the projects NPV and vice versa. Also, we need to be concerned

with WACC because form an investors point of view it is the opportunity cost of capital that the

investor will invest in the company. If the rate of return the company generates is less than

WACC, investors will be less likely to invest in such a company.

Any insights into the capital structure of ACME Iron?

Capital structure is the combination of equity and debt a company uses to end up

financing its overall growth and operations (Martin & Baker, 2013). In 2015 Acmes capital

structure comprised of 54.84% equity & 45.16% debt. Also the companys debt to equity ratio in

2015 of =140,350,000 / 170,423,000 = 0.82354 was greater than the industry average of 0.4 for

the year 2015 (Csimarket, 2019). Therefore, Acme aggressively financed its growth using debt

rather than equity when compared to its competitors

Running head: TEAM 2 PROJECT: TASK 3

Team Project: Task 3

Anthony Geckeler

Ayoade Ademiluyi

Desiree Porquet

Florence Akadje

Jay Stevens

Tanja Detwiler

February 28, 2020

1

TEAM 2 PROJECT: TASK 3

2

Executive Summary

As we continue to illustrate Acmes strategic financial plan, we need to show the CFO and

management team an example of the application of the previously constructed WACC. Acme is

planning the construction of a new loading ramp for its single iron mill. The initial cost of the

investment is $1 million. Efficiencies from the new ramp are expected to reduce costs by

$100,000 for the life of the plant which is currently estimated at another 30 years. Acme has an

after-tax cost of debt of 8% and a cost equity of 12% (they are currently funded equally by debt

and equity). In this task, we will find out when the project breaks even on a simple cash basis

(simple payback period) and on a discounted cash basis (discounted payback period). Also, we

will determine if Acme should pursue the capital investment of constructing a new loading ramp

by calculating the NPV.

WACC

Our first step in this analysis is to determine the WACC, which we explained from our task last

week. This step is significant because it gives us a discount rate to calculate the NPV. WACC is

the cost of each capital component multiplied by its proportional weight and then summed, as

shown below. In this case, the capital components are split evenly 50/50. The cost of debt is 8%,

and the cost of equity is 12%. This gives us a WACC of 10%, through the calculations shown

below:

TEAM 2 PROJECT: TASK 3

Capital Component

3

Proportion

Cost

Proportion X Cost

Equity

50%

12%

6%

Debt

50%

8%

4%

WACC

SUM of Column =

10%

This calculation gives us our discount rate for calculating NPV at 10%. Acme should not pursue

the capital investment unless the return was higher than 10%. We also use this discount rate of

10% for the calculation of the discounted payback period to find out when the project will break

even.

Cash Flows

First, we need to find the annual cash flows after-tax. This calculation is done by taking the

savings of the project and subtracting depreciation to get to EBIT. Depreciation, in this case, is

done on a straight-line method with the 1-million-dollar asset being evenly depreciated over 30

years. Next, we subtract taxes and assume a 40 percent tax rate. Then we add back our

depreciation because we are only looking at cash flows, and we only subtracted the deprecation

previously to calculate the tax amount. Our annual cash flow after taxes then is $73,333.33:

TEAM 2 PROJECT: TASK 3

4

Cost of Project

1,000,000.00

Savings of Project

100,000.00

Less Depreciation

33,333.33

EBIT

Less Taxes

66,666.67

40%

26,666.67

Add Backs

33,333.33

Annual Cash Flows after Tax

73,333.33

Payback Period

For the calculation of the payback period with simple cash flows, we take our initial cash

outflow of 1,000,000 in year 0 and add the cash savings of $73,333.33 after each year to it (see

below on the left). The break-even point is where the Sum of CF turns from a negative to a

positive, which, in our case, is between years 13 and 14. To find out exactly when, we divide the

left-over sum of cash flows from year 13 by the cash inflow in year 14: 46,666.71/73,333,33=

0.64 +13 years = 13.64 years. This number is not very realistic because it neglects the cost of

capital. A more realistic calculation is the discounted payback period calculation (UMUG, 2020,

Capital Investment Decisions).

TEAM 2 PROJECT: TASK 3

5

For the calculation of the payback period with discounted cash flows, we calculate the present

values for each of the 30 cash inflows (PV=$73,333.33/(1+0.1)^YEAR) and then calculate the

sum of cash flows after each year (UMGC, 2020, Capital Investment Decisions). With a discount

rate of 0.1, the present values of the cash inflows decrease steadily with each year, so that, with

discounted cash flows, the project does not break even within its lifetime (The Sum of CFs

remains negative throughout its lifetime). Since it is not breaking even, the project should be

rejected.

Year

Simple CFs

Sum of CFs

Year

Discounted CFs

Sum of CFs

0 (1,000,000.00) (1,000,000.00)

0 (1,000,000.00)

(1,000,000.00)

1 73,333.33

(926,666.67)

1 66,666.66

(933,333.34)

2 73,333.33

(853,333.34)

2 60,606.06

(872,727.28)

3 73,333.33

(780,000.01)

3 55,096.42

(817,630.86)

4 73,333.33

(706,666.68)

4 50,087.65

(767,543.21)

5 73,333.33

(633,333.35)

5 45,534.23

(722,008.98)

6 73,333.33

(560,000.02)

6 41,394.75

(680,614.23)

7 73,333.33

(486,666.69)

7 37,631.59

(642,982.64)

8 73,333.33

(413,333.36)

8 34,210.54

(608,772.10)

9 73,333.33

(340,000.03)

9 31,100.49

(577,671.61)

10 73,333.33

(266,666.70)

10 28,273.17

(549,398.43)

11 73,333.33

(193,333.37)

11 25,702.88

(523,695.55)

12 73,333.33

(120,000.04)

12 23,366.26

(500,329.29)

13 73,333.33

(46,666.71)

13 21,242.05

(479,087.24)

14 73,333.33

26,666.62

14 19,310.96

(459,776.28)

15 73,333.33

99,999.95

15 17,555.42

(442,220.86)

TEAM 2 PROJECT: TASK 3

6

16 73,333.33

173,333.28

16 15,959.47

(426,261.39)

17 73,333.33

246,666.61

17 14,508.61

(411,752.78)

18 73,333.33

319,999.94

18 13,189.64

(398,563.14)

19 73,333.33

393,333.27

19 11,990.59

(386,572.55)

20 73,333.33

466,666.60

20 10,900.53

(375,672.02)

21 73,333.33

539,999.93

21 9,909.57

(365,762.45)

22 73,333.33

613,333.26

22 9,008.70

(356,753.74)

23 73,333.33

686,666.59

23 8,189.73

(348,564.01)

24 73,333.33

759,999.92

24 7,445.21

(341,118.80)

25 73,333.33

833,333.25

25 6,768.37

(334,350.43)

26 73,333.33

906,666.58

26 6,153.07

(328,197.36)

27 73,333.33

979,999.91

27 5,593.70

(322,603.67)

28 73,333.33

1,053,333.24

28 5,085.18

(317,518.49)

29 73,333.33

1,126,666.57

29 4,622.89

(312,895.60)

30 73,333.33

1,199,999.90

30 4,202.63

(308,692.97)

NPV

The Net Present Value or NPV is very important in determining if the project should be pursued

or not. The Net Present Value will allow us to determine the cash flows received in todays

dollars. A million dollars today will not be worth the same amount in 30 years. So, we need to

discount all the cash inflows to present value, add them up and subtract the initial investment to

get to the NPV (which is a dollar amount). A project with a negative NPV should be rejected;

and a project with a positive NPV should be accepted (UMUC, 2020, NPV and IRR).

TEAM 2 PROJECT: TASK 3

7

Knowing the discount rate is 10%, the annual cash flows are $73,333.33 each year and the initial

cash outlay is $1,000,000, we can put these numbers in excel and use the NPV formula in excel

to get a -$308,692.97 Net Present Value. As seen below:

Discount

Rate

Year

After tax annual cash flows

Year

10%

After tax annual cash flows

0

-1,000,000.00

16

73,333.33

1

73,333.33

17

73,333.33

2

73,333.33

18

73,333.33

3

73,333.33

19

73,333.33

4

73,333.33

20

73,333.33

5

73,333.33

21

73,333.33

6

73,333.33

22

73,333.33

7

73,333.33

23

73,333.33

8

73,333.33

24

73,333.33

9

73,333.33

25

73,333.33

10

73,333.33

26

73,333.33

11

73,333.33

27

73,333.33

TEAM 2 PROJECT: TASK 3

8

12

73,333.33

28

73,333.33

13

73,333.33

29

73,333.33

14

73,333.33

30

73,333.33

15

73,333.33 NPV

-308,692.97

Conclusion and Recommendations

Since the project has a negative NPV of -$308,692.97, it should be rejected. The discounted

payback period calculation (which is more realistic than the simple payback calculation) comes

to the same conclusion as the NPV: The project should be rejected.

ACME Irons discount rate is very high, which leads to a negative NPV. ACME Iron could try to

lower its discount rate, which means lowering its WACC. It could lower its WACC by reducing

the weight of its expensive cost of equity (Cost of Equity is 12%). It could do so by increasing

the weight of its debt and obtaining loans with lower interest rates.

TEAM 2 PROJECT: TASK 3

9

Reference

UMGC. (2020). Capital investment decisions – payback period. Retrieved from

https://learn.umuc.edu/d2l/le/content/444475/viewContent/17279707/View

UMGC. (2020). Net Present Value (NPV) and Internal Rate of Return (IRR). Retrieved from

https://learn.umuc.edu/d2l/le/content/444475/viewContent/17279695/View

Task 4 – ACME IRON’s Real Option

Initial Investment

Discount Rate

Annual cash flows

YEAR

1

2

3

4

5

6

7

8

9

10

NPV

Good Results

$

(50.000.000)

10%

$

15.000.000

CASH FLOWS

15.000.000,00

15.000.000,00

15.000.000,00

15.000.000,00

15.000.000,00

15.000.000,00

15.000.000,00

15.000.000,00

15.000.000,00

15.000.000,00

$ 42.168.506,59

Bad Results

$

(50.000.000)

10%

$

2.000.000

CASH FLOWS

$

2.000.000

$

2.000.000

$

2.000.000

$

2.000.000

$

2.000.000

$

2.000.000

$

2.000.000

$

2.000.000

$

2.000.000

$

2.000.000

$ (37.710.865,79)

Real Option

Initial Investment

Discount Rate

Annual Cash Flows

$

YEAR

NPV

(50.000.000)

10%

$

8.500.000

CASH FLOWS

1

8.500.000,00

2

8.500.000,00

3

8.500.000,00

4

8.500.000,00

5

8.500.000,00

6

8.500.000,00

7

8.500.000,00

8

8.500.000,00

9

8.500.000,00

10

8.500.000,00

$ 2.228.820,40

Capital Budegeting Decision Tree

Good Results (50%

of $15 million

annual cash flows)

Test

Enterprise System

Test

Enterprise System

($50 million)

No Test

Risk Adjusted Cost of Capital

Experience with the focus of the project

0,5%

Chance of changes to estimated variables

0,5%

Potential Changes in …

Purchase answer to see full

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Our academic writers and editors will help you submit a well-structured and organized paper just on time. We will ensure that your final paper is of the highest quality and absolutely free of mistakes.

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Revising your paper

Our academic writers and editors will help you with unlimited number of revisions in case you need any customization of your academic papers