Question

**** This is for BA 498, need this tonight by 4pm****

In chapter 8 we discuss the financial issues surrounding investment in new projects. In particular, does the project make financial sense and how should we fund it (earnings, debt, or equity). You will find an investment scenario below with the details captured in a spreadsheet (attached). Just to simplify the example, we are ignoring factors such as the time value of money, restrictive terms on the equity investment, and economic growth rates. In practice, this type of analysis can get very involved. Please examine this model and answer the three questions below. You are encouraged to work on this together with your classmates and share your work. The idea here is to get comfortable with this type of financial analysis and working with models/numbers to reach a decision. Have fun with it!

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John’s Barley Mill is considering adding a new production line to its existing facility. The new production line will increase John’s sales revenue by $1 million/year. Sales of this offering have a gross margin of 70% and the cost of operating the new line is another 50% of sales on an annual basis. The new production line will cost $3 million to develop and install. The expected lifetime of this new equipment is 10 years. The company has the opportunity to finance this purchase through their bank with debt financing at 9% per year over 5 years. The company can also accept equity financing from an outside investor. They will have to give this new investor 20% ownership in the company in exchange for these funds. There is not indication that this investor will consider a scenario with less than 20% ownership - the returns have to make sense for their portfolio. The company currently has a market valuation of $20 million. If the company chooses to expand, and continues to hit its projections, which are extremely conservative, the valuation will increase by at least 10%/year in the current environment. The valuation will not increase if the company does not expand.

(1) Is this a business level or a corporate level strategy?

(2) Would equity or debt financing be preferable given the terms presented?

(3) Should John's move forward with this expansion?

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Answer 1

1. Business level strategy is a strategy that concerns developing competitive advantage. A firm must be able to supply a product or services more closely fitted to clients needs than rival firm.

Corporate Level Strategy on the other hand is mainly is concerned with what type of businesses the company should venture into (in line with company's mission and vision) compete with the development and coordination of that portfolio of businesses. Corporate Level Strategy is made up of strategic plans at the highest organization and corporate level. It involves portfolio analysis, diversification and primary structure. It is not restricted to just one particular area such as marketing, personnel, production/operational or financial implications, all the departments that were mentioned are all taken into consideration.

Thus the introduction of NEW PRODUCTION LINE to the existing facility is a BUSINESS LEVEL STRATEGY for John Barley Mill.

2. On working out the numerical Debt repayment gives interest payment of approx 7.36 lakh $ on the loan of $ 3 million for 5 years at 9% ROI which is more expensive than giving 20% ownership in the company of value $ 20 million. But as a business level strategy diluting the ownership is never an intelligent step. So the firm should take that business loan and by the time the new production line breaks even, the loan would have been repaid completely and thus the entire revenue from the new production line would be just to increase the profit of the firm.

3. This looks like and expensive purchase with Sales of the offering with Gross Margin 70% and cost of operating is also high i.e 50% of annual sales. Life of production line is only 10 years. However even with loan of $ 3 million the firm will be able to generate profit with this new production line after repaying the loan in 5 years time.