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Assignment Length – minimum 3,600 words and no more than 4,400 words.
NOTE – your Table of Contents, all Appendices and the References list are all excluded from the overall word count.
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With its dominance of the athletic shoe business, Flyte Inc. has generated £2,127M in operating net income on sales of £19,176M in the financial year ended 31 December 2017. Although its share price has rebounded, its sales and earnings are being affected by increased competition.
For your information, the following extracts are provided:
|Cost of Sales||11,354||10,213||10,571||10,240|
|Earnings before Interest and Tax||2,765||2,475||2,637||2,434|
|Earnings per Share (whole £ only)||4.39||3.86||3.03||3.74|
|Share Price (whole £ only)||42||75||78||109|
Flyte Inc. is now considering expansion into the teen / young adult market producing high-end casual footwear.
As Chief Finance Officer (CFO), you have been tasked with making an assessment on the following:
- You estimate it will cost Flyte Inc. £1.1M to gain a presence in this new market segment. Of this amount, £1M will need to be spent immediately acquiring land, equipment and other assets needed. There will be an additional and final investment of £100,000 at the end of year two. The segment will be operational at the start of year three.
- You have employed a major market-testing organisation to do market research, which has already been completed and expensed at £250,000 and provided you with the information you need in making a presence in this segment.
- The total market for this footwear is currently estimated at £75M in Sales, growing at 5% annually. Flyte Inc. is expected to gain a 2% market share in year three (the year it enters the market), increasing by 5% annually, to reach its plateau by year seven. After year seven, Flyte Inc.’s sales are expected to grow at the same rate as the overall market.
- Pre-tax Gross Profit margins (prior to depreciation, advertising and corporate costs) are expected to be 23% of sales.
- Flyte Inc. will allocate 5% of its existing General and Administrative costs to this new segment, which now total £2M overall and are expected to grow at 5% annually for the next seven years. Flyte Inc. will also have an increase of £50,000 in General and Administrative costs in year three when this new segment starts generating sales, which will be allocated to this segment.
- Advertising costs in 2018 are at £1M – this segment will take up 7% of these total advertising costs and will grow by 4% each year.
- Beta is at 0.91, Risk-free rate is 2.5%, Rate expected on Market return is 8%.
- Flyte Inc. expects to finance this expansion using a mix of debt and equity – its current levels are at 35% debt to 65% equity.
- Tax rates are at 24%.
- Cost of Capital is at 12%.
a. Assuming 2018 is Year 0, calculate the Net Present Value to Year 3 (or 2021) when expansion is ready to launch. State whether you accept or reject this proposal. Give reasons for your decision. (10 marks)
b. Calculate the effect of the Net Present Value change after four more years – to Year 7. State whether you accept or reject this proposal. Give reasons for your decision. (12 marks)
c. Calculate the Net Present Value change at Year 3 with inflation rate applied of 3%. Then apply same inflation rate through to Year 7. State whether you accept or reject this proposal. Give reasons for your decision. (10 marks)
d. Critically analyse the advantages and disadvantages of using Net Present Value as an investment appraisal method and evaluate alternative investment appraisal techniques. (10 marks)
e. Calculate the Capital Asset Pricing Model (CAPM). Assess the outcome and evaluate the characteristics of using CAPM. (8 marks)
f. After examining the various appraisal techniques, provide a supported recommendation to the CEO and Board of Flyte Inc. on the proposal to expand into this new segment. (5 marks) Task 2 45 marks
a. The CEO of Flyte Inc. has asked your advice on the risk appetite of the Board and shareholders considering its current debt / equity ratio and would like to increase leverage. Analyse the consequences of changing Flyte Inc.’s capital structure and how it can be problematic. Your answer needs to include the factors that influence capital decisions and strategy. (10 marks)
b. Discuss how corporate finance affects lenders, shareholders and managers. Include real life examples to support your answer and apply these to Flyte Inc. Your answer also needs to include the conflicts between the stakeholders themselves. (15 marks)
c. Compare the frameworks that could be considered for Flyte Inc.’s capital structure. Within your answer explain how Flyte Inc. need to contemplate contemporary issues around their capital structure. (10 marks)
d. The CEO of Flyte Inc. also needs help in understanding principles when it comes to codes of ethics as he has been concerned with balancing shareholder wealth maximisation and ethical standards. Critically discuss the issues around codes of ethical standards and corporate finance. Use real-life examples where necessary to support your answer. (10 marks)