Question #1.

Humongous Inc. is a large publicly traded manufacturer of health care products. It has a reputation as oneof the best-managed companies in the U.S.A. However, the company recently came under fierce criticismby the government for charging exorbitant prices to consumers.Investors have responded negatively tofears that the government would reform the health care sector and make an attempt to reign in prices. As a result of these fears, Humongous’s stock price lost 30% of its value in the past year.

To try to appease the government and counter possible government intervention, Humongous justpurchased Teeney Corp., a discount health care supplier. Investors have responded positively to thisacquisition, pushing Humongous’s stock price back up by over 10% since news of the acquisition becamepublic.

While Humongous Inc.’s acquisition of TeeneyCorp. could provide Humongous with a foothold in a growing part of the discount health care sector, a real problem lies in the mission of Teeney Corp.   Teeneyhas built a successful business by providing consumers with unbiased, objective health care advice and guiding them to the best prices available. However, now that it is owned by Humongous, Teeney’scustomers have expressed doubts about whether Teeney can remain objective and unbiased in recommending the best health care products at the best price.

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Assume that you are a manager charged with bringing Teeney Corp. into Humongous Corp and helpingthe two companies to integrate. Please answer the questions below. Please make sure to break up your answer into paragraphs, starting a new paragraph whenever you start a new idea.

Are you facing an ethical issue? Why or why not? Do Teeney’s customers have reason to doubt the futureobjectivity of the company? Why or why not? If this is a problem, what steps can you take to mitigate that problem? (This answer could be about one or two paragraphs).

As a manager charged with bringing Teeney into Humongous, what are your ethical and legal obligations to Humongous? To Teeney? To the customers of both? What do you owe shareholders? Are there other stakeholders? If so, what do you owe them? (This answer could be about two or 3paragraphs).

In February, Cap Inc. announced that it would split into two independent publicly traded companies: one comprised of its Old Navy brand, and the second a yet-to-be-named company that includes its other brands like Banana Republic and Athleta. The planned breakup is an acknowledgment of the two chains' diverging fortunes and how much Gap has lost its once-powerful grip on American consumers. For several years, Old Navy has outperformed its sister brands Gap and Banana Republic with its lower price-points and catchy marketing. Old Navy now exceeds the original brand in sales, making up nearly half of Gap Inc.'s $16.6 billion of sales in 2018.

In your opinion, what are the benefits and downsides to splitting Gap into two firms? How did Gap's stock react to the news in after-market trading? How would you explain this reaction? Will the separation save the company in the long run? Please elaborate on your answers.

Publicly traded companies, including those specializing in e-commerce, are required to file financial data with the Securities and Exchange Commission. By analyzing this information, you can determine the profitability of an e-commerce company and the viability of its business model.

Pick on e-commerce company on the Internet, for example, Buy.com, Yahoo.com, or Priceline.com. Study the web pages that describe the company and explain its purpose and structure. Use the web to find articles that comment on the company. Then visit the Securities and Exchange Commission’s web site at www.sec.gov (Links to an external site.) and select Filings and Forms to access the company’s 10-K (annual report) form showing income statements and balance sheets. Select only the sections of the 10-K form containing the desired portions of financial statements that you need to examine, and download into your spreadsheet. Create simplified spreadsheets of the company’s balance sheets and income statements for the past two years. Create some graphs for quick reference to the data.

Is the company a dot-com success, borderline business, or failure? What information forms the basis of your decision? Why? When answering these questions, pay special attention to the company’s two-year trends in revenues, cost of sales, gross margins, operating expenses, and net margins.

You and your team are financial consultants who have been hired by a large, publicly traded electronics firm, Brilliant Electronics (BI), a leader in its industry. The company is looking into manufacturing its new product, a machine using sophisticated state of the art technology developed by BI’s R&D team, overseas. This overseas project will last five years. They’ve asked you to evaluate this project and to make a recommendation about whether or not the company should pursue it. BI’s management team needs your recommendation and the analysis used to arrive at it by no later than December 4, 2019.

The following market data on BI’s securities are current:

Debt: 210,000 6.4 percent coupon bonds outstanding, 25 years to maturity, selling or 108 percent of par; the bonds have $1000 par value each and make semi-annual payments

Common Stock: 8,300,000 shares outstanding, selling for $68 per share; beta=1.1

Preferred Stock: 450,000 shares of 4.5% preferred stock outstanding, selling or $81 per share

Market: 7 percent expected market risk premium; 3.5 percent risk-free rate

The company bought some land three years ago for $3.9 million in anticipation of using it as a toxic dump site for waste chemicals, but it built a piping system to safely discard the chemicals instead. The land was appraised last week for $4.4 million on an after-tax basis.   In five years, the after-tax value of the land will be $4.8 million, but the company expects to keep the land for a future project. The company wants to build its new manufacturing plant on this land; the plant will cost $37 million to build.

At the end of the project (the end of year 5), the plant can be scrapped for $5.1 million. The manufacturing plant will be depreciated using the straight line method.

The company will incur $6,700,000 in annual fixed costs excluding depreciation. The plan is to manufacture 15,300 machines per year and sell them at $11,450 per machine; the variable production costs are $9,500 per machine. Selling price and costs are expected to remain unchanged over the life of the project.

BI uses PK Global (PKG) as its lead underwriter. PKG charges BI spreads of 8% on new common stock issues, 6% on new preferred stock issues, and 4% on new debt issues. PKG has included all direct and indirect issuance costs (along with its profit) in setting these spreads. BI’s tax rate is 35 percent. The project requires $1,300,000 in initial net working capital investment to get operational. Assume BI raises all equity for new projects externally (that is, BI does not use retained earnings).

The weighted average flotation cost is the sum of the weight of each source of funds in the capital structure of the company times the flotation costs, so:

f_T = ($564.4/$827.65)(0.08) + ($36.45/$827.65)(0.06) + ($226.8/$827.65)(0.04) = 0.0682, or 6.82%

Thus the initial investment is increased by the amount of flotation costs:

                    (Amount raised)(1 – 0.0682) = $37,000,000   

                    Amount raised = $37,000,000/(1 – 0.0682) = $39,708,092

Your analysis should include, and your recommendation should be based on, the following:

1. Calculate the firm’s current cost of capital using the information provided.

2. Calculate the project’s cost of capital (the appropriate discount rate to use to evaluate BI’s new project) assuming the capital structure will remain the same if the project is undertaken.

This project is somewhat riskier than a typical project for BI; therefore, management has asked you to use an adjustment factor of 12% to account for this increased riskiness (that is, to add 12% to the firm’s cost of capital) to estimate the project’s required rate of return.

(NOTE: Flotation costs do not have to be considered when calculating the required rate of return for each class of security – they are addressed in this problem by adjusting the cost of the initial investment to $39,708,092 from $37,000,000).

3. Calculate the project’s annual cash flows, taking into account all the relevant cash flows.
   1. Calculate the project’s initial Time 0 cash flow, taking into account all relevant cash flows.
   2. Calculate the project’s annual operational cash flows (OCF) over the life of the project.
   3. Calculate the project’s terminal (last year of the project) cash flow.   Include all relevant cash flows.

                (Note: You can present the cash flows from Year 0 to Year 5 in a table format)

4. What is the NPV and IRR of the project?

Consider the portfolio of projects described in the table. The resource requirements are in numbers of labor hours. The Greatest Resource Utilization rule would begin work with project:

Options:

A.

B.

C.

D.

(a) use the data n the table to construct a standardized p-chart,

(b) interpret your chart, and

(c) give reasons for out-of-control conditions

Gallatin Carpet Cleaning is a small, family-owned business operating out of Bozeman, Montana. For its services, the company has always charged a flat fee per hundred square feet of carpet cleaned. The current fee is $23.10 per hundred square feet. However, there is some question about whether the company is actually making any money on jobs for some customers—particularly those located on remote ranches that require considerable travel time. The owner’s daughter, home for the summer from college, has suggested investigating this question using activity-based costing. After some discussion, she designed a simple system consisting of four activity cost pools. The activity cost pools and their activity measures appear below:

The total cost of operating the company for the year is $359,000 which includes the following costs:

Resource consumption is distributed across the activities as follows:

Job support consists of receiving calls from potential customers at the home office, scheduling jobs, billing, resolving issues, and so on.

Required:

1. Prepare the first-stage allocation of costs to the activity cost pools.

2. Compute the activity rates for the activity cost pools.

3. The company recently completed a 200 square foot carpet-cleaning job at the Flying N Ranch—a 59-mile round-trip journey from the company’s offices in Bozeman. Compute the cost of this job using the activity-based costing system.

4. The revenue from the Flying N Ranch was $46.20 (200 square feet @ $23.10 per hundred square feet). Calculate the customer margin earned on this job.

Gallatin Carpet Cleaning is a small, family-owned business operating out of Bozeman, Montana. For its services, the company has always charged a flat fee per hundred square feet of carpet cleaned. The current fee is $22.60 per hundred square feet. However, there is some question about whether the company is actually making any money on jobs for some customers—particularly those located on remote ranches that require considerable travel time. The owner’s daughter, home for the summer from college, has suggested investigating this question using activity-based costing. After some discussion, she designed a simple system consisting of four activity cost pools. The activity cost pools and their activity measures appear below:

The total cost of operating the company for the year is $347,000 which includes the following costs:

Resource consumption is distributed across the activities as follows:

Job support consists of receiving calls from potential customers at the home office, scheduling jobs, billing, resolving issues, and so on.

Required:

1. Prepare the first-stage allocation of costs to the activity cost pools.

2. Compute the activity rates for the activity cost pools.

3. The company recently completed a 800 square foot carpet-cleaning job at the Flying N Ranch—a 58-mile round-trip journey from the company’s offices in Bozeman. Compute the cost of this job using the activity-based costing system.

4. The revenue from the Flying N Ranch was $180.80 (800 square feet @ $22.60 per hundred square feet). Calculate the customer margin earned on this job.

Review the provisions of the Sarbanes-Oxley Act of 2002 to address the accounting scandals in the late 1990s and early 2000s (Enron, WorldCom, etc.)BELOW:

Identify the provisions that you believe made the most significant impact. What other provisions could have been included in the Act to strengthen the responsible stewardship and integrity of the accounting profession? Conversely, what existing provisions in the Act do you believe (if any) are unnecessary or over-regulate the profession?

As a result of corporate accounting scandals, such as those at Enron and WorldCom, the U.S. Congress enacted the Sarbanes-Oxley Act of 2002 (SOX). The purpose of SOX is to restore trust in publicly traded corporations, their management, their financial statements, and their auditors. SOX enhances internal control and financial reporting requirements and establishes new regulatory requirements for publicly traded companies and their independent auditors. Publicly traded companies have spent millions of dollars upgrading their internal controls and accounting systems to comply with SOX regulations.

As shown in Exhibit 1-10, SOX requires the company’s CEO and CFO to assume responsibility for their company’s financial statements and disclosures. The CEO and CFO must certify that the financial statements and disclosures fairly present, in all material respects, the operations and financial condition of the company. Additionally, they must accept responsibility for establishing and maintaining an adequate internal control structure and procedures for financial reporting. The company must have its internal controls and financial reporting procedures assessed annually.

Some Important Features of SOX

SOX also requires audit committee members to be independent; that is, they may not receive any consulting or advisory fees from the company other than for their service on the board of directors. In addition, at least one of the members should be a financial expert. The audit committee oversees not only the internal audit function but also the company’s audit by independent CPAs.

To ensure that CPA firms maintain independence from their client company, SOX does not allow CPA firms to provide certain nonaudit services (such as bookkeeping and financial information systems design) to companies during the same period of time in which they are providing audit services. If a company wants to obtain such services from a CPA firm, it must hire a different firm to do the nonaudit work. Tax services may be provided by the same CPA firm if pre-approved by the audit committee. The audit partner must rotate off the audit engagement every five years, and the audit firm must undergo quality reviews every one to three years.

SOX also increases the penalties for white-collar crimes such as corporate fraud. These penalties include both monetary fines and substantial imprisonment. For example, knowingly destroying or creating documents to “impede, obstruct, or influence” any federal investigation can result in up to 20 years of imprisonment.

SOX also contains a “clawback” provision in which previously paid CEO’s and CFO’s incentive-based compensation can be recovered if the financial statements were misstated due to misconduct. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 further strengthens the clawback rules, such that firms must recover all incentive compensation paid to any current or former executive, in the three years preceding the restatement, if that compensation would not have been paid under the restated financial statements. In other words, executives will not be allowed to profit from misstated financial statements, even if the misstatement was not due to misconduct.

john is the president of a consulting firm named Dye Optimalization from Intellectural Thinking (DO-IT). Suppose DO-IT is thinking about undertaking a project to expand its current business activities by creating an advisory business that will enable clients to benefit from distance learning coupled with interactive sessions.

DO-IT is a publicly traded company that has a stock price of

$24 per share with 2,000,000 shares outstanding. In addition, DO-IT has outstanding debt with a face value of $10,000,000 that is currently selling at a price of 120% with a yield of 6%.

The risk free rate currently is 3% and DO-IT's equity cost of capital is 12%. The DO-IT company is a profitable firm that pays a corporate tax rate of 25%.

john is considering a project that would require an immediate expenditure of $750,000 for equipment to expand its current business activities. This equipment would have a 3 year life with zero salvage value and zero disposal cost; and the equipment will be depreciated via the straight line depreciation method. Prior to considering depreciation expense and tax effects, the equipment itself will be responsible for generating additional gross profits of $475,000 annually for each of the 3 years of its useful life. Also, the project and equipment have no impact on net working capital.

Should DO-IT make the purchase? Be sure to show all your work and clearly put forth your thought process.