Question

Astor Industrial Supply is a manufacturer and distributor of standard and custom gaskets, seals, converted products, and machined parts. It provides sealing and other industrial solutions to markets ranging from defense, aerospace, power generation, mining, wastewater treatment, electronics, pharmaceutical, and food and beverage.

On January 2, 2016, Travis Allen, the executive vice president and CFO of Astor Company, was preparing for the January meeting of the Capital Budget Committee (CBC).The CBC is considering 7 projects representing over $30,000,000 in capital expenditures from its two operational segments. Unfortunately, the CBC has imposed a spending limit on the total investment and has mandated to not exceed the firms internal funds. With the new fiscal year, there was a need to determine which projects best fits the Company’s future growth value enhancement. Thus, the challenge for the Committee was to allocate the funds among competing projects efficiently to increase the Company’s value.

The Company

With over 200 years of combined expertise in the sealing industry, Astor Industrial Supply fabricates and distributes custom gaskets for customers in various industries including defense, aerospace, power generation, mining, electronics, pharmaceutical, and food and beverage. Astor has two operational segments, EMI Shielding and Fabrication and Machinery, and currently is considering ten new investments for both segments.

EMI Shielding

As a fabricator and distributor of EMI shielding products, Astor provides shielding solutions for the aerospace, defense, and electronics industries. Typically shielding is applied to enclosures, separating electrical devices from the 'outside world', and to cables, separating wires from the environment the cable runs through. The shielding can reduce the coupling of radio waves, electromagnetic fields, and electrostatic fields though not static or low frequency magnetic fields. The amount of reduction depends very much upon the material used, its thickness, and the frequency of the fields of interest. Projects for EMI Shielding are listed below.

Table 1- EMI Shielding

Expand aerospace facilities at the Illinois

Expand defense facilities at Indiana

Purchase electronic equipment for fabrication

Special handling equipment for aerospace facilities in Illinois

Fabrication & Machining

Astor also offers a wide variety of machined and fabricated products with varying applications for a large industrial demographic.

With your print, sketch, or sample we can fabricate parts to meet your requirements. We also provide value added plastic fabrication services that complement your in-house resources. Our material lists are extensive allowing us to provide solutions for any environment. We use various adhesives and heat forming techniques to produce shields, enclosures, displays, and covers using acrylic, polycarbonate, ABS, and Sintra. Projects for Fabrication & Machining are listed below.

Table 2- Fabrication & Machining (F&M)

Purchase electronic equipment for fabrication

Purchase of four plastic molding machine for fabrication

Purchase of four heat forming equipment for fabrication

Capital Budget Committee and Project Selection

The Capital Budget Committee at Astor is composed of Travis Allen and his two associates. Typically, his associates solicit investment proposal from managing directors and if the project cost exceeds $500,000, it required the approval of CBC. For this year, the directors have recommended 7 projects which exceeded the capital expenditure limits. Table 1-3 provides a brief description of the projects and initial cost and the estimated cash flow of each project (after tax profit plus depreciation) over its estimated life.

Table 3- Projects	EMI 1	EMI 2	EMI 3	EMI 4	F&M1	F&M2	F&M3
Year	Initial Investment	Initial Investment	Initial Investment	Initial Investment	Initial Investment	Initial Investment	Initial Investment
0	($5,000,000)	($3,500,000)	($3,000,000)	($4,000,000)	($5,000,000)	($5,000,000)	($5,000,000)
1	$950,000	$1,250,000	$550,000	$1,250,000	$900,000	$1,500,000	$500,000
2	$950,000	$1,000,000	$550,000	$1,250,000	$900,000	$1,400,000	$650,000
3	$950,000	$850,000	$550,000	$1,250,000	$900,000	$1,300,000	$750,000
4	$950,000	$650,000	$550,000	$1,000,000	$900,000	$1,000,000	$800,000
5	$950,000	$550,000	$550,000	$1,000,000	$900,000	$750,000	$900,000
6	$950,000	$450,000	$550,000	$1,000,000	$900,000	$650,000	$1,000,000
7	$950,000	$350,000	$550,000		$900,000	$500,000	$1,100,000
8	$950,000	$250,000	$550,000		$900,000	$450,000	$1,500,000
9	$950,000		$550,000		$900,000	$300,000	$1,750,000
10	$950,000		$550,000		$900,000	$300,000	$2,000,000
Net CF	$4,500,000	$1,850,000	$2,500,000	$2,750,000	$4,000,000	$3,150,000	$5,950,000

Table-4 Balance Sheet (in thousands)
Assets
Current Assets	31-Dec-12	31-Dec-13	31-Dec-14	31-Dec-15	31-Dec-16
Cash And Cash Equivalents	$18,057	$18,017	$17,977	$17,937	$17,897
Net Receivables	$138,844	$143,800	$148,755	$153,711	$158,666
Inventory	$127,965	$133,563	$139,162	$144,760	$150,359
Other Current Assets	$25,852	$22,993	$20,135	$17,276	$14,418
Total Current Assets	$310,718	$318,373	$326,029	$333,684	$341,340
Long Term Investments	$82,392	$87,422	$92,452	$97,482	$102,512
Property Plant and Equipment	$686,858	$709,237	$731,616	$753,995	$776,374
Goodwill	$10,181	$10,162	$10,143	$10,124	$10,105
Accumulated Amortization	($108,082)	($113,230)	($118,379)	($123,527)	($128,676)
Other Assets	$74,924	$84,985	$95,047	$105,108	$115,170
Total Assets	$1,056,991	$1,096,949	$1,136,908	$1,176,866	$1,216,825
Liabilities
Current Liabilities
Accounts Payable	$88,511	$93,948	$81,337	$74,455	$65,375
Current Long Term Debt due	$10,000	$10,000	$10,000	$10,000	$10,000
Total Current Liabilities	$98,511	$103,948	$91,337	$84,455	$75,375
Long Term Debt	$150,000	$150,000	$150,000	$150,000	$150,000
Total Liabilities	$248,511	$253,948	$241,337	$234,455	$225,375
Preferred Stock (par $100, yield 8% and 1.25 million shares)	$125,000	$125,000	$125,000	$125,000	$125,000
Stockholders' Equity
Common Stock ( Class A owners,20 million shares)	$200,000	$200,000	$200,000	$200,000	$200,000
Retained Earnings	$429,870	$469,802	$511,930	$556,257	$602,780
Capital Surplus	$164,758	$164,758	$164,758	$164,758	$164,758
Other Stockholder Equity	$13,852	$8,442	$18,882	$21,397	$23,912
Total Stockholder Equity	$808,480	$843,002	$895,570	$942,412	$991,450
Total Liabilities and Equity	$1,056,991	$1,096,949	$1,136,907	$1,176,867	$1,216,825

Table 5- Income Statement (in thousands)	31-Dec-12	31-Dec-13	31-Dec-14	31-Dec-15	31-Dec-16
Total Revenue	$1,189,783	$1,242,778	$1,295,773	$1,348,768	$1,401,763
Cost of Revenue	$638,646	$668,180	$697,714	$727,248	$756,782
Gross Profit	$551,137	$574,598	$598,059	$621,520	$644,981
Selling General and Administrative	$292,572	$302,465	$312,357	$322,250	$332,142
Others	$108,082	$113,230	$118,379	$123,527	$128,676
Operating Income or Loss	$150,483	$158,903	$167,323	$175,743	$184,163
Total Other Income/Expenses Net	$6,965	$7,920	$8,875	$9,830	$10,785
Earnings Before Interest And Taxes	$143,518	$150,983	$158,448	$165,913	$173,378
Interest Expense	$1,071	$1,212	$1,353	$1,494	$1,635
Income Before Tax	$142,447	$149,771	$157,095	$164,419	$171,743
Income Tax Expense	($56,978)	($59,908)	($62,837)	($65,767)	($68,696)
Net Income From Continuing Ops	$85,469	$89,863	$94,258	$98,652	$103,047
Net Income	$85,469	$89,863	$94,258	$98,652	$103,047
Preferred Stock And Other Adjustments	$10,000	$10,000	$10,000	$10,000	$10,000
Net Income Applicable To Common Shares	$75,469	$79,863	$84,258	$88,652	$93,047
Dividends	$37,734	$39,932	$42,129	$44,326	$46,523

Financial Information

At the end of 2016, the Company had net income of $103,047 and total asset was $1,216,825 consisting of $730,095 from to EMI Shielding segment and $486,730 from Fabrication & Machining services.

On the basis of its net income, Travis wants to know how much money is available for capital investments. Its established common stock’s dividend payout ratio after the preferred stock dividends payment is 50 percent of the funds. Currently the preferred stock has a 8 percent dividend yield with a par value of $100. A 12 percent cost of capital for funds generated internally has been used in the past, and Woods sees no reason to depart from this figure. Any additional funds used for capital budgeting purposes will have to come from external financing. In discussions with the Hughes brothers, Woods informed them that any additional external funds will have a 14 percent rather than the 12 percent current cost of capital.

Questions:

How much of the internal fund is available for investments?

Which quantitative methods are useful to evaluate the projects?

Discuss the strengths and weaknesses of the quantitative methods you used to select the projects.

Which quantitative ranking results in the highest value to the company?

Are there any conflicts among the rankings of the projects? How do you resolve the conflict in ranking?

What project(s) should the CBC should recommend for the coming year based on 12 and 14 percent cost of capital?

Are there any issues about the projects that CBC did not consider before the recommendation?

Answer 1

Q-1.net income applicable to equity shareholders is $93047 as on 31st DEC'16(table 5).company pays out 50% of this that,is $46523 as dividends (dividend payout ratio is given as 50%).So in ternal fund available for investment is 93047-46523= $46524(in thousands)= $46524000

Q-2. Method used for evaluation can be Net present value method using cost of capital of 12%

NPV= present value of cash inflows - initial investment

Project1

This gives an inflow of 950000 for ten years , Multiplying this by present value interest factor of an assnuity of $1 at 12% for 10 years, that is5.650 , we get 5367500.and outflow is given as 5000000

So NPV = 5367500-5000000=$367500

Project2

This gives different cash inflows each year.SO to get present value of cash inflows we multiply the cash inflows of each year with the respective present value interest factor at 12%

So present value of cash inflows=1250000*0.893+1000000*0.797+850000*0.712+ 650000*0.636+550000*0.567+450000*0.507+350000*0.452+250000*0.404=3731050 and initital investment is given as 3500000

So NPV= 3731050-3500000=$231050

Project 3

This project gives annuity of 550000 for 10 years So to get present value of cash inflows, we multiply 550000 by present value interest factor for an annuity ,that is 5.650 .So present value of inflows = 3107500. and initial investment is given as3000000

So NPV= 3107500-3000000= $107500

Project 4

Since cashflows are different each year we multiply by the respective present value factors

1250000*0.893+1250000*0.797+1250000*0.712+1000000*0.636+1000000*0.567+1000000*0.507= 4712500

So NPV = 4712500- 4000000= $712500

Project 5

Present value of cash inflows = 900000*5.650= 5085000. and initial investment= 5000000

So NPV= 5085000-5000000=$85000

Project 6

Present value of cash inflows= 1500000*0.893+1400000*0.797+1300000*0.712+1000000*0.636+750000*0.567+650000*0.507+500000*0.452+450000*0.4041+300000*0.361+300000*0.322= 5384400

So NPV= 5384400-5000000= $384400

Project 7

Multiplying the cash flows by respective present value factors, we get present value of cash inflows=5403600

NPV= 5403600-5000000=$403600

company can rank the projects on the basis of descending order of NPVs for selecting the projects