Question

Sharco Systems Inc., a manufacturer of auto parts, wants to make inroads in the European and Asian markets. Sharco’s executives know it will be difficult because of the strongly entrenched existing competitors in those markets. However, the company executives believe that if they formulate effective business goals and strategies and raise the resources required to implement their plans, they could become viable competitors in these markets.
The company’s statement of income and statement of financial position are presented below. As shown, in 2014, the company earned $176 million in profit for the year on assets of $2.0 billion.
Sharco Systems Inc.
Statement of Income
For the year ended December 31, 2014
(in $ millions)
Revenue ................. 2,500
Cost of sales ................ (1,610)
Gross profit ............... 890
Expenses
Distribution costs ............. (260)
Administrative expenses ........... (120)
Depreciation ............... (100)
Finance costs .............. (90)
Total expenses .............. (570)
Profit before taxes ............ 320
Income tax expense ........... (144)
Profit for the year ............ 176
The before-tax cost of financing the equity and debt as shown on the statement of financial position is as follows:
Bank loans ................. 8.0%
Current portion of long-term borrowings ..... 7.0%
Mortgage ................ 6.0%
Debentures ................ 7.0%
Equity ................. 12.0%


The company had to prepare a prospectus to raise $350 million from the following sources:
In millions
Common shares ........... $100
Retained earnings* ......... 70
Preferred shares ........... 30
Long-term borrowings .......... 150
Total ................. $350

These funds would be used almost exclusively to expand their operations in Europe and Asia, which would generate a return of 22% on the company’s investments. The company’s vice-president of finance provided the following information:
• Common share dividend yield is estimated at 7% and growth rate during the past five years has been 6%. (This rate is expected to continue.)
• Internal funding from retained earnings is estimated at $70 million.
• Preferred shares would be sold at $75 and bear a 10% yield.
• Cost of new debt is expected to be 10%.

1. Calculate the following:
a. Sharco’s before- and after-tax cost of financing for 2014
b. Sharco’s before- and after-tax ROA for 2014 and compare them with your answers to Question 1a
c. Sharco’s economic value added for 2014
d. The company’s cost of capital to raise funds from the following:
• Common shares only
• Preferred shares only
• Long-term borrowings only
• All sources (WACC)
2. Should Sharco go ahead with theproject?


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  • CreatedDecember 03, 2014
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