Solution Pages: 3
Files that you will download:
Word (.docx) & Excel (.xlsx)
Questions Covered in the Solution
1. What are the impacts on operating cycle and cash conversion cycle due to the increase in the payment period (i.e., average collection period) from 30 to 60 days? Also, assuming the company is currently selling 100 bikes per day, by how much should the firm increase or reduce its working capital financing to accommodate to this change in average collection period?
2. Based on the forecasted sales, is it possible for to achieve the corresponding cash and accounting break-even points? Based on your
calculations for each – and from a pure cost management perspective – is the marketing department’s proposal acceptable? Explain.
3. Calculate the weighted average cost of capital of Shery using available information (estimate the cost of equity using capital asset
pricing model – CAPM).
4. Use Payback, Net-Present Value (NPV), and IRR to assess whether the investment in the new machines is warranted (assume a payback cut-off period of 7 years and use Shery’s weighted average cost of capital as the discount rate). Also, explain to the BoD the benefits of the NPV vis-a-vis other capital budgeting methodologies.
5. If the market price of the Treasury bonds is currently at $1100 per unit, whereas the stock of XYZ is trading at $10 per share, which
investment should Shery sell to raise the necessary funds? Explain the reasons behind your decision.
6. Based on the answers to the previous questions, determine whether to endorse the plan suggested by the marketing department to the BoD. Then discuss potential suggestions on how to improve the campaign.
7. Discuss the limitation of the above analyses.
Sample of Solution
Question no. 1
Both the operating cycle and cash conversion cycle have increased by 30 days due to an increase in the payment period. We know that DSO (days sales outstanding) is given by:
DSO = Accounts Receivables / Sales per day
If we keep initial DSO (30 days), we get accounts receivables of $1,860,000. If DSO doubles (60 days), accounts receivables will also double. This means that the firm should increase its working capital financing by $1,860,000 to accommodate the change in the average collection period.
Question no. 5
The stock is being traded at $10 in the market; the stock price calculated via the dividend discount model is $10.50. It means the market is offering less than the price of the stock (i.e., the stocks are undervalued in the market). On the other hand, the T-bond is valued in the market at $1,100. However, our calculations show that the value of T-bonds is $1,081. It means that T-bills are overvalued in the market. Hence, it will be better for the company to sell T-bonds to raise the necessary financing.
Question no. 7
There are a lot of limitations that can be associated with the analysis in the previous questions. We will discuss those limitations one by one.
- The company’s WACC may not be an appropriate discount rate for this project. This project may have a different risk level than the overall risk of the company. Hence, the company should evaluate the risk level of this project to estimate an appropriate discount rate.