Optimal Capital Structure with Hamada

Beckman Engineering and Associates (BEA) is considering a change in its capital structure. BEA currently has $20 million in debt carrying a rate of 7%, and its stock price is $40 per share with 2 million shares outstanding. BEA is a zero growth firm and pays out all of its earnings as dividends. The firm's EBIT is $14.386 million, and it faces a 40% federal-plus-state tax rate. The market risk premium is 6%, and the risk-free rate is 4%. BEA is considering increasing its debt level to a capital structure with 30% debt, based on market values, and repurchasing shares with the extra money that it borrows. BEA will have to retire the old debt in order to issue new debt, and the rate on the new debt will be 8%. BEA has a beta of 1.0.

What is the total value of the firm with 30% debt? Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Do not round intermediate calculations. Round your answer to three decimal places.
$   million

1. What is BEA's unlevered beta? Use market value D/S (which is the same as w_d/w_s) when unlevering. Do not round intermediate calculations. Round your answer to two decimal places.
2. What are BEA's new beta and cost of equity if it has 30% debt? Do not round intermediate calculations. Round your answers to two decimal places.
   Beta:  
   Cost of equity:   %
3. What are BEA’s WACC and total value of the firm with 30% debt? Do not round intermediate calculations. Round your answer to two decimal places.
     %

A petroleum refinery can handle the processing of two grades of
crude oils, #1 and #2, to produce four kinds of products gasoline, kerosene, fuel oil and
residual.
The total costs include raw material costs and processing costs. The raw material costs for the
crude oils are $24/bbl for #1, and $15/bbl for #2. The processing costs are $0.5/bbl for #1, and
$1.0/bbl for #2.
The sales prices of the products are $36/bbl for gasoline, $24/bbl for kerosene, $21/bbl for fuel
oil and $10/bbl for residual.
The following is the information for the product yield (volume percent of raw material) and
maximum allowable production of each product (bbl/day):
One bbl crude oil #1 can produce 0.80 bbl gasoline, 0.05 bbl kerosene, 0.10 bbl fuel oil, and
0.05 bbl residual. One bbl crude oil #2 can produce 0.44 bbl gasoline, 0.10 bbl kerosene, 0.36
bbl fuel oil, and 0.10 bbl residual. The maximum allowable production for gasoline is 24,000
bbl/day, for kerosene is 2,000 bbl/day, and for fuel oil is 6,000 bbl/day, and no maximum
allowable production limitation for residual.
(1) Based on the data above, derive a mathematical formulation for this linear programming
problem and determine: The optimum feed schedule (bbl/day) of the two crude oils for the
maximum profit, using method of simultaneous equations. How much is the maximum profit
($/day)?
(2) Comment on how variation of raw material costs and sales prices will affect the feed
schedule and profitability on this kind of project in industry.

The management team of Accent Group Limited have received a proposal from the manager of Hype DC. This proposal concerns a major upgrade to Hype DC's stores to improve the customer experience. Key details relating to this proposal include:

• The initial cost will be $22 million. This cost will be depreciated using the straight line method over the 5 year life of the upgrade.
• During year 1, the firm will increase marketing costs by $2.0 million to promote the store upgrades.
• Over the five year life of the project, it is expected that the upgrade will increase the firm's sales by $18 million per year. On average, cost of sales is 45% of revenue.
• The firm will need to higher additional staff over the life of the project to help to deal with the increased sale volume. In year 1, the firm's staffing costs will increase by $1.0 million. These costs will increase by 3.5% p.a.
• The upgrade is expected to increase the firm's energy costs by $500,000 in year 1. This increase will be ongoing across the life of the project and will increase by 6% p.a.
• Upgraded stores will include an old shoe recycling drop off zone. This recylcing program will cost $75,000 in year 1. These costs will increase by 2% p.a.
• At the end of year 3, the firm will spend $1.5 million on a minor refurbishment to the stores.

The firm’s tax rate is 30%. The firm requires a 16% required rate of return on all potential investments.

1. Provide an overview of the key environmental and social factors that the firm should consider in evaluating the proposal
2. Discuss how sensitive your recommendations are to changes in assumptions in regards to the financial impact of the new capital investment. In your discussion, include examples which illustrate how changes to at least two assumptions impact the financial analysis .

The management team of Accent Group Limited have received a proposal from the manager of Hype DC. This proposal concerns a major upgrade to Hype DC's stores to improve the customer experience. Key details relating to this proposal include:

• The initial cost will be $22 million. This cost will be depreciated using the straight line method over the 5 year life of the upgrade.
• During year 1, the firm will increase marketing costs by $2.0 million to promote the store upgrades.
• Over the five year life of the project, it is expected that the upgrade will increase the firm's sales by $18 million per year. On average, cost of sales is 45% of revenue.
• The firm will need to higher additional staff over the life of the project to help to deal with the increased sale volume. In year 1, the firm's staffing costs will increase by $1.0 million. These costs will increase by 3.5% p.a.
• The upgrade is expected to increase the firm's energy costs by $500,000 in year 1. This increase will be ongoing across the life of the project and will increase by 6% p.a.
• Upgraded stores will include an old shoe recycling drop off zone. This recylcing program will cost $75,000 in year 1. These costs will increase by 2% p.a.
• At the end of year 3, the firm will spend $1.5 million on a minor refurbishment to the stores.

The firm’s tax rate is 30%. The firm requires a 16% required rate of return on all potential investments.

1. Provide an overview of the key environmental and social factors that the firm should consider in evaluating the proposal
2. Discuss how sensitive your recommendations are to changes in assumptions in regards to the financial impact of the new capital investment. In your discussion, include examples which illustrate how changes to at least two assumptions impact the financial analysis .

The management team of Accent Group Limited have received a proposal from the manager of Hype DC. This proposal concerns a major upgrade to Hype DC's stores to improve the customer experience. Key details relating to this proposal include:

• The initial cost will be $22 million. This cost will be depreciated using the straight line method over the 5 year life of the upgrade.
• During year 1, the firm will increase marketing costs by $2.0 million to promote the store upgrades.
• Over the five year life of the project, it is expected that the upgrade will increase the firm's sales by $18 million per year. On average, cost of sales is 45% of revenue.
• The firm will need to higher additional staff over the life of the project to help to deal with the increased sale volume. In year 1, the firm's staffing costs will increase by $1.0 million. These costs will increase by 3.5% p.a.
• The upgrade is expected to increase the firm's energy costs by $500,000 in year 1. This increase will be ongoing across the life of the project and will increase by 6% p.a.
• Upgraded stores will include an old shoe recycling drop off zone. This recylcing program will cost $75,000 in year 1. These costs will increase by 2% p.a.
• At the end of year 3, the firm will spend $1.5 million on a minor refurbishment to the stores.

The firm’s tax rate is 30%. The firm requires a 16% required rate of return on all potential investments.

1. Discuss how sensitive your recommendations are to changes in assumptions in regards to the financial impact of the new capital investment. In your discussion, include examples which illustrate how changes to at least two assumptions impact the financial analysis .

One of the main functions of saliva is to buffer against acid from food and plaque, which contributes significantly to the formation of cavities. While there are several buffers in saliva, carbonic acid (H2CO3) has the highest concentration and has the greatest effect on pH.

(a) While the salivary concentration of carbonic acid stays at a fairly constant 1.3 mM, the level of bicarbonate (HCO3-) can vary with the rate that saliva flows from salivary glands. For low flow rates, the bicarbonate concentration is around 2 mM; for medium flow rates, it is 30 mM; and for high flow rates, around 60 mM. The pKa of carbonic acid at body temperature is 6.1. Assuming that the pH of Saliva is determined primarily by carbonic acid and bicarbonate, determine the pH of saliva for each of the three flow rates. The normal pH of saliva is about 6.3.

(b) The most prevalent bacterium in the mouth, streptococcus mutans, breaks down sugar and releases lactic acid (pKa = 3.86). If S. mutans has produced 10^-8 moles of lactic acid since your last swallow, what is the pH of your saliva? What would the pH be without the bicarbonate buffer? Assume that your mouth contains about 1 mL of saliva and that your saliva is flowing at a low rate.

(c) You take a drink of orange juice, and after you swallow, 0.5 mL remains in your mouth. What is the pH of your saliva if your mouth contains 1 mL of pure saliva, and if you model orange juice as 1.0 mM citric acid (pKa = 3.13; assume only one dissociation).

(d) Why do some toothpastes contain baking soda (sodium bicarbonate)?

Marty’s Mask produces a variety of masks used in industrial and healthcare settings as well as plastic masks used in costumes. Due to the current pandemic, Marty is going to produce only masks that are useful in a healthcare setting and will focus on three models – N95, disposable surgical and plastic shields (simple retooling and changing of the material allows the plastic masks machines to make the shields). Marty is limited by the number of machine hours available and has a higher demand for the masks than can currently be met. Current production capabilities are limited by the 200,000 machine hours per week. Following is information for each of these products:

*20% of the fixed costs are unavoidable regardless of how many of each unit is produced

A. In order to maximize the company’s total contribution margin, in what sequence should Marty fill orders?

B. How many of each should Marty produce?

C. What are three other possible criteria/issues Marty should consider besides maximizing contribution margin when evaluating the order in which to produce the masks?

Part II

Question 2:

Wood World manufactures many wooden products. One of its popular product lines is the wooden crate line. It currently produces 100,000 crates monthly and this production volume represents 80% of capacity. These crates are sold in their unfinished form (no paint or stain) and are used by individuals and businesses in various ways. College students often stack them to make shelves and storage areas. Wood World is considering adding paint, various stains and even decoupage to 25% of the crates and selling them as their “designer crate line.” A single unfinished crate consists of $7 in direct materials, $12 in direct labor, $3 in variable manufacturing overhead $5 in fixed manufacturing overhead and sells for $40. The designer crate line would add the following: $4 in direct materials, $8 in direct labor, and $2 in variable manufacturing overhead and $1 in additional fixed costs. Market studies indicate a designer crate can be sold for $55.

A. Should Wood World sell all the crates in the unfinished form or should it process them further into designer crates? Why? (be sure to back up your explanation with numbers)

B. Would your answer change if Wood World was operating at capacity? Why or why not?

C. What are three non-quantitative issues Wood World should consider in making this decision?

Part II

Question 3:

Louis Luggage produces many different types and sizes of luggage. Their best seller, the Weekend Warrior, sells for $140. Louis has been asked by Macrosoft, Inc. to produce 2,000 of the Weekend Warrior with a specially designed fingerprint security lock and with the Macrosoft company logo. These will be given to Macrosoft employees who must travel frequently for work. Macrosoft has offered to pay $120 per suitcase. Louis’ costs related to the Weekend Warrior consist of variable costs per unit of $50 and fixed costs per unit of $35 of which $9 are unavoidable. In addition, Louis will encounter additional variable costs of $10 per unit for the security lock component and $4,000 as a one-time fixed cost for the Macrosoft label.

A. What is the operating income generated by the special order?

B. Should the special order be accepted? Why or why not?

C. What are three other considerations that Louis, or any company, should think about when choosing whether to accept a special order?

Part II

Question 4:

Cassie’s Clowns produces clown costumes and other party favors and supplies and has three divisions – Funny, Scary and Sad. Based on the latest information presented to the CEO by the controller, a discussion has ensued as to the fate of the Scary division. The division is operating at a loss. The manager of the Scary Division, Vam Pire, argues that his division is profitable and that the company will be worse off it they close the Scary Division. Here is the latest information for Cassie’s Clowns:

Of the fixed S&A costs, 15% represent common costs that have been allocated equally to each product line. In addition, 25% of Scary’s fixed production costs are unavoidable as these are fixed costs associated with facilities and equipment shared by all three divisions.

A. Is Vam Pire correct – should the Scary Division be kept or eliminated? Why or why not?

B. What would be total corporate income if Scary Division is eliminated currently?

C. What are two areas Cassie and in particular Scary’s management should look at to improve Scary’s bottom line?

D. What are three qualitative things that Cassie should consider when deciding if a division is eliminated?

Part II

Question 5:

Ace Acting Co. is a professional actor training group that trains stage actors and is headquartered in Los Angeles. The CEO of the company, Allen Ace, is considering expanding and opening an office in New York City but he just received an interesting business opportunity in the San Francisco area to partner with a movie production company located there. Mr. Ace knows he can only accept one of these opportunities at the current time. He has already purchased his non-refundable ticket to New York for $525 however the ticket can be exchanged for a voucher for a future trip. To ensure that he was able to stay in the appropriate location within each city, he has already made hotel reservations. These reservations are cancelable except for a 5% cancellation fee. The hotel in New York is $650 total for the two nights and the San Francisco hotel is $500 for the length of the stay. If he goes to New York, Mr. Ace plans to purchase a ticket to see Hamilton on Broadway at a cost of $400. He will also incur taxi fees of $100 and expects to spend $200 for meals in New York and $300 in San Francisco. Since he would be able to drive from Los Angeles to San Francisco, he would get reimbursed $250 for mileage. Mr. Ace will pay for all costs and will be reimbursed by his company for business expenses.

Required:

A. What are the relevant costs of each trip?

B. What are the incremental costs (and what is the total incremental cost)?

C. Without considering qualitative factors (thus use numbers to analyze), which alternative should Allen choose? Why?

D. What are three qualitative factors that Allen might consider?

E. Why is it important to use relevant costs and revenues when evaluating decisions?