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?

Case 6-1  Chobani

Chobani LLC, is a producer and marketer of Greek yogurt. The company was founded in 2005 by Hamdi Ulukaya, an immigrant from Turkey, who recognized the lack of options for high-quality yogurt in the United States. The company is headquartered in Norwich, New York, and it employs approximately 2,000 employees. It operates two manufacturing plants—its original facility in central New York and a second new state-of-the-art facility in Twin Falls, Idaho.

The mission of the company is “To provide better food for more people. We believe that access to nutritious, delicious yogurt made with only natural ingredients is a right, not a privilege. We believe every food maker has a responsibility to provide people with better options, which is why we’re so proud of the way our food is made.” Chobani’s core values are integrity, craftsmanship, innovation, leadership, people, and giving back.

The company’s beginning in 2005 occurred when Hamdi Ulukaya discovered a notice about an old Kraft yogurt factory in South Edmeston that was closed. He decided to obtain a business loan in order to purchase it. Between 2005 and 2007, Ulukaya worked with four former Kraft employees and yogurt master Mustafa Dogan to develop the recipe for Chobani Greek Yogurt. Between 2007 and 2009, the company started to sell its yogurt in local grocery stores including Stop and Shop and ShopRite. By 2010, Chobani Greek yogurt became the best selling Greek yogurt in the United States. The company pursued global expansion by entering Australia in 2011 and the United Kingdom in 2012. In 2013, the company opened its international headquarters in Amsterdam, and Hamdi Ulukaya was named the Ernst and Young World Entrepreneur of the Year.

Chobani has achieved its success in large part due to its ability to innovate in its product lineup. For example, in 2016, it launched a new line of yogurt drinks, more flavors of its Flip mix-in product, and even a concept café in Manhattan.

The company also created a food incubator program that is designed to provide resources, expertise (e.g., brand and marketing, packaging and pricing), and funding to small, young companies that have promising ideas for new natural foods that they aspire to develop.

Although Hamdi Ulukaya has been extremely successful in his founding and establishment of Chobani, he has recognized that there are some key lessons learned from his experience as the head of a young but very successful and industry-leading company. These include the importance of hiring people with functional experience such as marketing, supply chain, logistics, operations, and quality control, as they were essential to the smooth operation of the company. In addition, remembering to respect the competition and not to underestimate it is critical, as Chobani’s two main competitors, Dannon and Yoplait, launched their own Greek yogurt lines, and they were able to win back some of Chobani’s market share over time.

Discussion Questions

5.   Think about managing change at a personal level. Why is it so hard for so many people to change their behavior or way of thinking? Are these personal challenges to managing change also relevant to managing change in organizations?

6.   What can you learn from Hamdi Ulukaya about what is needed to become a successful entrepreneur?

Case 6-1  Chobani

Chobani LLC, is a producer and marketer of Greek yogurt. The company was founded in 2005 by Hamdi Ulukaya, an immigrant from Turkey, who recognized the lack of options for high-quality yogurt in the United States. The company is headquartered in Norwich, New York, and it employs approximately 2,000 employees. It operates two manufacturing plants—its original facility in central New York and a second new state-of-the-art facility in Twin Falls, Idaho.

The mission of the company is “To provide better food for more people. We believe that access to nutritious, delicious yogurt made with only natural ingredients is a right, not a privilege. We believe every food maker has a responsibility to provide people with better options, which is why we’re so proud of the way our food is made.” Chobani’s core values are integrity, craftsmanship, innovation, leadership, people, and giving back.

The company’s beginning in 2005 occurred when Hamdi Ulukaya discovered a notice about an old Kraft yogurt factory in South Edmeston that was closed. He decided to obtain a business loan in order to purchase it. Between 2005 and 2007, Ulukaya worked with four former Kraft employees and yogurt master Mustafa Dogan to develop the recipe for Chobani Greek Yogurt. Between 2007 and 2009, the company started to sell its yogurt in local grocery stores including Stop and Shop and ShopRite. By 2010, Chobani Greek yogurt became the best selling Greek yogurt in the United States. The company pursued global expansion by entering Australia in 2011 and the United Kingdom in 2012. In 2013, the company opened its international headquarters in Amsterdam, and Hamdi Ulukaya was named the Ernst and Young World Entrepreneur of the Year.

Chobani has achieved its success in large part due to its ability to innovate in its product lineup. For example, in 2016, it launched a new line of yogurt drinks, more flavors of its Flip mix-in product, and even a concept café in Manhattan.

The company also created a food incubator program that is designed to provide resources, expertise (e.g., brand and marketing, packaging and pricing), and funding to small, young companies that have promising ideas for new natural foods that they aspire to develop.

Although Hamdi Ulukaya has been extremely successful in his founding and establishment of Chobani, he has recognized that there are some key lessons learned from his experience as the head of a young but very successful and industry-leading company. These include the importance of hiring people with functional experience such as marketing, supply chain, logistics, operations, and quality control, as they were essential to the smooth operation of the company. In addition, remembering to respect the competition and not to underestimate it is critical, as Chobani’s two main competitors, Dannon and Yoplait, launched their own Greek yogurt lines, and they were able to win back some of Chobani’s market share over time.

Discussion

1. Start with a brief (1-2 paragraphs) summary of the case.

2. List the management issues short term & longer term you see in the case.

3.Propose a solution to fix the major current problem and a longer term course of action to prevent the problem.

Mike Cichanowski founded Wenonah Canoe and later purchased Current Designs, a company that designs and manufactures kayaks. The kayak-manufacturing facility is located just a few minutes from the canoe company’s headquarters in Winona, Minnesota.

Current Designs makes kayaks using two different processes. The rotational molding process uses high temperature to melt polyethylene powder in a closed rotating metal mold to produce a complete kayak hull and deck in a single piece. These kayaks are less labor-intensive and less expensive for the company to produce and sell.

Its other kayaks use the vacuum-bagged composite lamination process (which we will refer to as the composite process). Layers of fiberglass or Kevlar^® are carefully placed by hand in a mold and are bonded with resin. Then, a high-pressure vacuum is used to eliminate any excess resin that would otherwise add weight and reduce strength of the finished kayak. These kayaks require a great deal of skilled labor as each boat is individually finished. The exquisite finish of the vacuum-bagged composite kayaks gave rise to Current Designs’ tag line, “A work of art, made for life.”

Current Designs has the following managers:

(c) When Diane Buswell, controller for Current Designs, reviewed the accounting records for a recent period, she noted the cost items and amounts shown below (amounts are assumed). Enter the amount for each item in the appropriate cost category. Then sum the amounts in each cost category column.

1. Lancaster Real Estate Company was founded 25 years ago by the current CEO, Robert Lancaster. 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 Lancaster 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 8 million shares of common stock outstanding. The stock currently trades at $37.80 per share.

Lancaster 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 Lancaster’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. 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 the possibility of financial distress and the associated costs would rise sharply. Lancaster has a 23 percent corporate tax rate (state and federal).

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

Johnson Real Estate Company was founded 25 years ago by the current CEO, David Johnson. 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 Johnson Real Estate, David was the founder and CEO of a failed camel farming operation. The resulting bankruptcy made him extremely averse to debt financing. As a result, the company is entirely equity financed, with 8 million shares of common stock outstanding. The stock currently trades at $37.80 per share. Johnson 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 Johnson's annual pretax earnings by $14.125 million in perpetuity. Abigail Burton, the company’s new CFO, has been put in charge of the project. Abigail 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 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. Johnson has a 23 percent corporate tax rate (state and federal). If Johnson wishes to maximize its total market value, would you recommend that it issue debt or equity to finance the land purchase? Explain.

Which of the following breaks down company financial information into specific time spans, and can cover a month, quarter, half-year, or full year?

1. accounting period
2. yearly period
3. monthly period
4. fiscal period

On which two financial statements would the Retained Earnings account appear?

1. Balance Sheet
2. Income Statement
3. Retained Earnings Statement
4. Statement of Cash Flows

What adjusting journal entry is needed to record depreciation expense for the period?

1. a debit to Depreciation Expense; a credit to Cash
2. a debit to Accumulated Depreciation; a credit to Depreciation Expense
3. a debit to Depreciation Expense; a credit to Accumulated Depreciation
4. a debit to Accumulated Depreciation; a credit to Cash

Which of these transactions requires an adjusting entry (debit) to Unearned Revenue?

1. revenue earned but not yet collected
2. revenue collected but not yet earned
3. revenue earned before being collected, when it is later collected
4. revenue collected before being earned, when it is later earned

What critical purpose does the adjusted trial balance serve?

1. It proves that transactions have been posted correctly
2. It is the source document from which to prepare the financial statements
3. It shows the beginning balances of every account, to be used to start the new year’s records
4. It proves that all journal entries have been made correctly.

Assume it is Sept 1, 2020. Company ABC using AUD as functional currency is concerned about currency risk. The company imports goods from the US and sells them in the Australian market with expected revenues for 2021 of AUD 11.5 million. The contract price for these goods from US suppliers is USD 6.5 million payable in one payment on March 1, 2021. The company has a target profit margin (profit as percentage of revenue) of 20%. The minimum acceptable profit margin below which the company will have difficulties servicing its debt is 15%. The spot AUD/USD rate on Sept 1, 2020 is 0.70. The Australian and US six-month interest rates are 2.5% and 2.0%, respectively. Furthermore, the following option contracts expiring on March 1, 2021 are currently available:

Strike AUD/USD rate           Premium

AUDCall 0.73                        0.015

AUDCall 0.68                        0.021

AUDCall 0.70                        0.017

AUDPut 0.72                       0.0125

AUDPut 0.68                        0.008

AUDPut 0.65                        0.005

Based on this information and the knowledge you gained while studying the FRM unit, respond to the questions below. Give all your answers for profit margins and currency rates with 4 (four) decimal places Problem

1) What would be the profit margin of the company if the current spot rate is used? Problem

2) What is the AUD/USD currency rate at which the company achieves exactly its target rate? Problem

3) What is the critical AUD/USD currency rate for the company? Problem

4) Give two examples of situations in which the company may not need to hedge its currency risks with derivatives.

The president of a university claims that the mean time spent partying by all students at this university is not more than 7 hours per week. A random sample of 30 students taken from this university showed that they spent an average of 9.50 hours partying the previous week with a standard deviation of 2.3 hours. Test at a significance level of 0.025 whether the president’s claim is true.

1. Write the null and the alternative hypothesis.
2. Calculate the test statistics.
3. Obtain the p-value.
4. Give your conclusion.