Jen and Larry’s Frozen Yogurt Company

     In 2019, Jennifer (Jen) Liu and Larry Mestas founded Jean and Larry’s Frozen Yogurt Company, which was based on the idea of applying the microbrew or microbatch strategy to the production and sale of frozen yogurt. Jen and Larry began producing small quantities of unique flavors and blends in limited editions. Revenues were $600,000 in 2019 and were estimated to be $1.2 million in 2020.

     Because Jen and Larry were selling premium frozen yogurt containing premium ingredients, each small cup of yogurt sold for $3, and the cost of producing the frozen yogurt averaged $1.50 per cup. Administrative expenses, including Jen and Larry’s salary and expenses for an accountant and two other administrative staff, were estimated at $180,000 in 2020. Marketing expenses, largely in the form of behind-the-counter workers, in-store posters, and advertising in local newspapers, were projected to be $200,000 in 2020.

     An investment in bricks and mortar was necessary to make and sell the yogurt. Initial specialty equipment and the renovation of an old warehouse building in lower downtown (known as LoDo) occurred at the beginning of 2019. Additional equipment needed to make the amount of yogurt forecasted to be sold in 2020 was purchased at the beginning of 2020. As a result, depreciation expenses were expected to be $50,000 in 2020. Interest expenses were estimated at $15,000 in 2020. The average tax rate was expected to be 25% of taxable income.

1. Jen and Larry believe that under a worst-case scenario, yogurt revenues would be at the 2019 level of $600,00 even after plans and expenditures were put in place to increase revenues in 2020. What would happen to the venture’s EBDAT?
2. Jen and Larry also believe that, under optimistic conditions, yogurt revenues could reach $1.5 million in 2020. Show what would happen to the venture’s EBDAT if this were to happen.

Stephenson Real Estate Company was founded 25 years ago by the current CEO, Robert Stephenson. The company purchases real estate, including land and buildings, and rents the property to tenants. The company has shown a profit every year for the past 18 years, and the shareholders are satisfied with the company’s management. Prior to founding Stephenson Real Estate, Robert was the founder and CEO of a failed alpaca farming operation. The resulting bankruptcy made him extremely averse to debt financing. As a result, thecompany is entirely equity financed, with 8 million shares of common stock outstanding. The stock currently trades at $37.80 per share. Stephenson is evaluating a plan to purchase a huge tract of land in the southeastern United States for $85 million. The land will subsequently be leased to tenant farmers. This purchase is expected to increase Stephenson’s annual pretax earnings by $14.125 million in perpetuity. Jennifer Weyand, the company’s new CFO, has been put in charge of the project. Jennifer has determined that the company’s current cost of capital is 10.2 percent. She feels that the company would be more valuable if it included debt in its capital structure, so she is evaluating whether the company should issue debt to entirely finance the project. Based on some conversations with investment banks, she thinks that the company can issue bonds at par value with a 6 percent coupon rate. Based on her analysis, she also believes that a capital structure in the range of 70 percent equity/30 percent debt would be optimal. If the company goes beyond 30 percent debt, its bonds would carry a lower rating and a much higher coupon because the possibility of financial distress and the associated costs would rise sharply. Stephenson has a 23 percent corporate tax rate (state and federal).

QUESTIONS

1. If Stephenson wishes to maximize its total market value, would you recommend that it issue debt or equity to finance the land purchase? Explain.

2. Construct Stephenson’s market value balance sheet before it announces the purchase.

3. Suppose Stephenson decides to issue equity to finance the purchase.

a. What is the net present value of the project?

b. Construct Stephenson’s market value balance sheet after it announces that the firm will finance the purchase using equity. What would be the new price per share of the firm’s stock? How many shares will Stephenson need to issue to finance the purchase?

c. Construct Stephenson’s market value balance sheet after the equity issue but before the purchase has been made. How many shares of common stock does Stephenson have outstanding? What is the price per share of the firm’s stock?

d. Construct Stephenson’s market value balance sheet after the purchase has been made.

4. Suppose Stephenson decides to issue debt to finance the purchase.

a. What will the market value of the Stephenson company be if the purchase is financed with debt?

Stephenson Real Estate Company was founded 25 years ago by the current CEO, Robert Stephenson. The company purchases real estate, including land and buildings, and rents the property to tenants. The company has shown a profit every year for the past 18 years, and the shareholders are satisfied with the company’s management. Prior to founding Stephenson Real Estate, Robert was the founder and CEO of a failed alpaca farming operation. The resulting bankruptcy made him extremely averse to debt financing. As a result, the company is entirely equity financed, with 11 million shares of common stock outstanding. The stock currently trades at $48.50 per share.

Stephenson is evaluating a plan to purchase a huge tract of land in the southeastern United States for $45 million. The land will subsequently be leased to tenant farmers. This purchase is expected to increase Stephenson’s annual pretax earnings by $10 million in perpetuity. Kim Weyand, the company’s new CFO, has been put in charge of the project. Kim has determined that the company’s current cost of capital is 10.5 percent. She feels that the company would be more valuable if it included debt in its capital structure, so she is evaluating whether the company should issue debt to entirely finance the project. Based on some conversations with investment banks, she thinks that the company can issue bonds at par value with a coupon rate of 7 percent. Based on her analysis, she also believes that a capital structure in the range of 70 percent equity⁄30 percent debt would be optimal. If the company goes beyond 30 percent debt, its bonds would carry a lower rating and a much higher coupon because the possibility of financial distress and the associated costs would rise sharply. Stephenson has a 40 percent corporate tax rate (state and federal).

• If Stephenson wishes to maximize its total market value, would you recommend that it issue debt or equity to finance the land purchase? Explain.
• Review Stephenson's market value balance sheet before it announces the purchase.
• Suppose Stephenson decides to issue equity to finance the purchase.
• • What is the net present value of the project?
  • Review Stephenson's market value balance sheet after it announces that the firm will finance the purchase using equity. What would be the new price per share of the firm's stock? How many shares will Stephenson need to issue to finance the purchase?
  • Review Stephenson's market value balance sheet after the equity issue but before the purchase has been made. How many shares of common stock does Stephenson have outstanding? What is the price per share of the firm's stock?
  • Review Stephenson's market value balance sheet after the purchase has been made.
• Suppose Stephenson decides to issue debt to finance the purchase.
• • What will the market value of the Stephenson company be if the purchase is financed with debt?
  • Review Stephenson's market value balance sheet after both the debt issue and the land purchase. What is the price per share of the firm's stock?
• Which method of financing maximizes the per-share stock price of Stephenson's equity?

Stephenson Real Estate Company was founded 25 years ago by the current CEO, Robert Stephenson. The company purchases real estate, including land and buildings, and rents the property to tenants. The company has shown a profit every year for the past 18 years, and the shareholders are satisfied with the company’s management. Prior to founding Stephenson Real Estate, Robert was the founder and CEO of a failed alpaca farming operation. The resulting bankruptcy made him extremely averse to debt financing. As a result, the company is entirely equity financed, with 9 million shares of common stock outstanding. The stock currently trades at $37.80 per share. Stephenson is evaluating a plan to purchase a huge tract of land in the southeastern United States for $95 million. The land will subsequently be leased to tenant farmers. This purchase is expected to increase Stephenson’s annual pretax earnings by $18.75 million in perpetuity. Jennifer Weyand, the company’s new CFO, has been put in charge of the project. Jennifer has determined that the company’s current cost of capital is 10.2 percent. She feels that the company would be more valuable if it included debt in its capital structure, so she is evaluating whether the company should issue debt to entirely finance the project. Based on some conversations with investment banks, she thinks that the company can issue bonds at par value with a 6 percent coupon rate. From her analysis, she also believes that a capital structure in the range of 70 percent equityy30 percent debt would be optimal. If the company goes beyond 30 percent debt, its bonds would carry a lower rating and a much higher coupon because the possibility of financial distress and the associated costs would rise sharply. Stephenson has a 40 percent corporate tax rate (state and federal). Please answer the questions below with separate papers.

1. If Stephenson wishes to maximize its total market value, would you recommend that it issue debt or equity to finance the land purchase? Explain. 2. Construct Stephenson’s market value balance sheet before it announces the purchase. Market value balance sheet Assets    Equity      Total assets    Debt and equity  

3. Suppose Stephenson decides to issue equity to finance the purchase.

a. What is the net present value of the project?

b. Construct Stephenson’s market value balance sheet after it announces that the firm will finance the purchase using equity. What would be the new price per share of the firm’s stock? How many shares will Stephenson need to issue to finance the purchase? Market value balance sheet Old assets       NPV of project   Equity      Total assets Debt and equity  

c. Construct Stephenson’s market value balance sheet after the equity issue but before the purchase has been made. How many shares of common stock does Stephenson have outstanding? What is the price per share of the firm’s stock? Market Value Balance Sheet Cash       Old assets          NPV of project   Equity      Total assets Debt and equity   d. Construct Stephenson’s market value balance sheet after the purchase has been made. Market Value Balance Sheet Old assets       PV of project      Equity      Total assets    Debt and equity  

4. Suppose Stephenson decides to issue debt to finance the purchase. a. What will the market value of the Stephenson company be if the purchase is financed with debt? b. Construct Stephenson’s market value balance sheet after both the debt issue and the land purchase. What is the price per share of the firm’s stock? Market Value Balance Sheet Value unlevered    Debt    Tax shield      Equity      Total assets    Debt and equity  

5. Which method of financing maximizes the per-share stock price of Stephenson’s equity?

Stephenson Real Estate Company was founded 25 years ago by the current CEO, Robert Stephenson. The company purchases real estate, including land and buildings, and rents the property to tenants. The company has shown a profit every year for the past 18 years, and the shareholders are satisfied with the company’s management. Prior to founding Stephenson Real Estate, Robert was the founder and CEO of a failed alpaca farming operation. The resulting bankruptcy made him extremely averse to debt financing. As a result, the company is entirely equity financed, with 9 million shares of common stock outstanding. The stock currently trades at $37.80 per share.

Stephenson is evaluating a plan to purchase a huge tract of land in the southeastern United States for $95 million. The land will subsequently be leased to tenant farmers. This purchase is expected to increase Stephenson’s annual pretax earnings by $18.75 million in perpetuity. Jennifer Weyand, the company’s new CFO, has been put in charge of the project. Jennifer has determined that the company’s current cost of capital is 10.2 percent. She feels that the company would be more valuable if it included debt in its capital structure, so she is evaluating whether the company should issue debt to entirely finance the project. Based on some conversations with investment banks, she thinks that the company can issue bonds at par value with a 6 percent coupon rate. From her analysis, she also believes that a capital structure in the range of 70 percent equityy30 percent debt would be optimal. If the company goes beyond 30 percent debt, its bonds would carry a lower rating and a much higher coupon because the possibility of financial distress and the associated costs would rise sharply. Stephenson has a 40 percent corporate tax rate (state and federal).

1. If Stephenson wishes to maximize its total market value, would you recommend that it issue debt or equity to finance the land purchase? Explain.

2. Construct Stephenson’s market value balance sheet before it announces the purchase.

3. Suppose Stephenson decides to issue equity to finance the purchase.

What is the net present value of the project?

Construct Stephenson’s market value balance sheet after it announces that the firm will finance the purchase using equity. What would be the new price per share of the firm’s stock? How many shares will Stephenson need to issue to finance the purchase?

Construct Stephenson’s market value balance sheet after the equity issue but before the purchase has been made. How many shares of common stock does Stephenson have outstanding? What is the price per share of the firm’s stock?

Construct Stephenson’s market value balance sheet after the purchase has been made.

4. Suppose Stephenson decides to issue debt to finance the purchase. What will the market value of the Stephenson company be if the purchase is financed with debt?

Construct Stephenson’s market value balance sheet after both the debt issue and the land purchase. What is the price per share of the firm’s stock?

5. Which method of financing maximizes the per-share stock price of Stephenson’s equity?

Founded in 1970 in Alençon (Orne), the company MPO Fenêtres (Menuiserie Plastique de l’Ouest) was one of the first French companies in the PVC/carpentry sector to offer a customized service. However, at that time, in France, very little was known about PVC, carpentry and double-glazing technology: these markets were still in their infancy. It took about ten years, and two oil crises (in 1974 and especially in 1979) for the PVC window market to really take off. The commercial policy of EDF (the French public energy provider) at that time favored the development of this product, encouraging investors to push for “all electric” installations, which would, according to the manufacturer provider, require better insulation of public buildings to reduce heat loss. With regard to marketing and distribution, the business is customer-oriented: therefore, MPO Fenêtres has chosen to keep control of the entire supply chain, right through from the order to delivery to (and sometimes installation for) the customer. For both new and replacement windows, MPO Fenêtres markets, designs, manufactures and installs its own products, thus ensuring complete control of the order and keeping to a minimum the number of contacts for the customer. The company distributes its products through two distribution channels: a central department in charge of “key accounts” and “communities”, and a network of eight agencies deployed in northeastern France, all owned by the company. These agencies are the cornerstone of the distribution network. Each agency employs fifteen salespersons, as the control of about 15% of its market area, and operates in a sales territory of approximately 45,000 customers. The company’s salespeople actively seek potential clients, especially at trade fairs and exhibitions. These events are of paramount importance: they afford opportunities to expand the client base and win new contracts. Up to 25% of the annual turnover of an agency can be attributed to contacts made during these events.

Today, the continuing strong growth of the market has encouraged MPO Fenêtres’s CEO to rethink the organizational model of its agencies. In order to improve performance and increase the commercial strength of the company, an audit of its business performance was conducted. Internal research within the company enabled the identification of tasks conducted by employees, and the time allocated to each task, over the course a year. The results are as follows. Each year, a salesperson has two weeks of training and five weeks of paid holidays (in accordance with employment law). Two weeks of their annual working time is devoted to attending trade fairs. In addition, the average salesperson is absent one week per year for personal reasons. In terms of the organization of their five-day working week, the Director observed that one day is devoted to purely administrative tasks (making appointments and reporting activities). For the remaining four days of the week, based on a working day of11 hours, one hour is devoted to the management of administrative problem sand urgent tasks, and one hour is taken as a lunch break. In terms of customer contacts, information obtained from sales staff showed that the average sale is concluded at the end of the third meeting, and that such meetings last on average about an hour. Convinced that high thermal performance PVC windows are the future of the company, the company’s directorate decided to develop sales of these as its primary strategic activity. It therefore needed to develop a marketing strategy for these products on the retail market. Some factors are key to the strategic approach needed: individuals are not necessarily aware of the technical features of the products. In addition, although they offer real benefits, triple-glazed products are more expensive. This may hinder sales of triple-glazed products, because many alternatives, which are cheaper and perform equally well, are still marketed, both in the company’s own catalogue and in those of its competitors. Although the triple-glazed products are better in terms of insulation and sophistication, their price may be an important deterrent.

Required:  

1. Identify the key factors for success from the passage

2. Suggest incentives to stimulate the staff to encourage their continued training and to support sales of the company product that will lead to competitive advantage

Explain briefly both answers

Silverline Electricals Limited was founded ten years ago by Jim and Wendy Birt. The company manufactures

and installs both traditional and contemporary models of lights for residential and commercial purposes.

Silverline Electricals Ltd has experienced rapid growth because of the new technology that increases the

energy efficiency of its systems and the introduction of new models of LED integrated lights. The company is

equally owned by Jim and Wendy holding 100,000 shares each.

In August 2018, Jim and Wendy have decided to value their holdings in the company for financial planning
purposes. To accomplish this, they have gathered the following information about their main competitors in
the industry

Last year, Silverline Electricals Ltd had an EPS of $0.52 and paid dividends to Jim and Wendy of $31,200 each.

The company also had a return on equity of 15%. Jim and Wendy believe a required rate of return of 12% for

the company is appropriate.

Required:
1. Assuming the company continues its current growth rate (growth rate should be inferred from the
data given) into the infinite period, what is the share price of the company?
(7marks)
2. To verify their calculations, Jim and Wendy have hired Richard Wang, a consultant. Richard was
previously an equity analyst, and he has a good understanding of the electrical Industry. Richard has
examined the company’s financial statements as well as those of its competitors. Although Silverline
Electricals Ltd currently has a technological advantage, Richard’s research indicates that Silverline
Electricals Ltd’s competitors are investigating other methods to improve efficiency. Given this, Richard
believes that Silverline Electricals technological advantage will last for only the next five years. After
that period, the company’s growth is likely to slow down to the industry average. Additionally,
Richard believes that the company’s required return currently is too high and so after year 5, the
industry average required return is a more appropriate rate for valuation. Taking Richard’s
assumptions into consideration, calculate the estimated share price of Silverline Electricals Ltd.

3. What is the industry average price-earnings ratio? What is Silverline Electricals Ltd’s price-earnings
ratio based on Richard’s estimation in part (2) above? Comment on any differences and explain why
these differences may exist?

4. After a discussion with Richard, Jim and Wendy agree that they wanted to increase the value of the
company’s equity. Like many small business owners, they want to retain control of the company and
do not want to sell shares to outside investors. They also feel that the company’s debt is at a
manageable level and do not want to borrow more money. What steps can they take to increase the
share price? - justify each of your suggestions.

Stephenson Real Estate Company was founded 25 years ago by the current CEO, Robert Stephenson. The company purchases real estate, including land and buildings, and rents the properties to tenants. The company has shown a profit every year for the past 18 years, and the shareholders are satisfied with the company’s management. Prior to founding Stephenson Real Estate, Robert was the founder and CEO of a failed alpaca farming operation. The resulting bankruptcy made him extremely averse to debt financing. As a result, the company is entirely equity financed, with 9 million shares of common stock outstanding. The stock currently trades at $37.80 per share.

Stephenson is evaluating a plan to purchase a huge tract of land in the southeastern United States for $95 million. The land will subsequently be leased to tenant farmers. This purchase is expected to increase Stephenson’s annual pre-tax earnings (EBIT) by $18.75 million in perpetuity. Jennifer Weyand, the company’s new CFO, has been put in charge of the project. Jennifer has determined that the company’s current cost of capital is 10.20%. She feels that the company would be more valuable if it included debt in its capital structure, so she is evaluating whether the company should issue debt to entirely finance the project. Based on some conversations with investment banks, she thinks that the company can issue bonds at par (face value) with a 6 percent coupon rate. From her analysis, she also believes that a capital structure in the range of 70 percent equity/30 percent debt would be optimal. If the company goes beyond 30 percent debt, its bonds would carry a lower rating and a much higher coupon because of the possibility of financial distress and the associated costs would rise sharply. Stephenson has a 40 percent corporate tax rate.

What after-tax cash flow must Stephenson be currently producing per year, assuming that its current cash flows remain constant each year?

Construct Stephenson’s market value balance sheet before it announces the purchase.

3)Suppose Stephenson decided to issue equity to finance the purchase.

What is the net present value of the land acquisition project?

Construct Stephenson’s market value balance sheet after it announces that the firm will finance the purchase using equity. (Assume that the value of the firm will immediately change to reflect the NPV of the new project.)

What would be the new price per share of the firm’s stock? How many shares will Stephenson need to issue to finance the purchase?

Construct Stephenson’s market value balance sheet after the equity issue, but before the purchase has been made. How many shares of common stock does Stephenson have outstanding? What is the price per share of the firm’s stock?

e)What is Stephenson’s weighted average cost of capital after the acquisition? What after-tax cash flow will be produced annually after the acquisition? What is the present value of this stream of after-tax cash flow? What is the stock price after the acquisition? Does this agree with your previous calculations?

Suppose Stephenson decides to issue debt to finance the purchase.

What will be the market value of the Stephenson company be if the purchase is financed with debt?

Construct Stephenson’s market value balance sheet after both the debt issue and the land purchase. What is the price per share of the firm’s stock?

c)What is Stephenson’s cost of equity if it goes forward with the debt issue? (Do not round your answer.)

d)What is Stephenson’s weighted average cost of capital if it goes forward with the debt issue? (Do not round your answer.)

e)What total after-tax cash flow is being generated by Stephenson after the acquisition?

f)What is the present value of this after-tax cash flow? What is the market value of equity? What is the stock price? Does this agree with your work from parts (a) and (b)?

Which method of financing maximizes the per-share price of Stephenson’s equity?

Does the resultant capital structure (with the land acquisition financed by debt) satisfy Jennifer’s concerns about the negative effects of moving beyond the optimal capital structure?