Solve the assignment:

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Advanced Corporate Finance and Modeling

Assignemnt

Grading will be established on the quality and depth of the explanations.

Note that some questions may have not have a definitive answer, so make sure to explain your reasoning centered on the knowledge you acquired in class:

- Financial Statement Analysis

- Short term finance / Working Capital Management - Project Cash Flows & Capital Budgeting Rules

- Weighted Average Cost of Capital

- Capital Structure: M&M Theorems

- Capital Structure: Financial Leverage and WACC

- WACC Calculation

- Trade-off Theory of Capital Structure

- Financial leverage - cost of capital M&M

- Corporate Payout Policy

- Share repurchase and other ending material payout policy

Connect your explanations to course materials. The test is not based on your general knowledge, but on advanced corporate finance and modeling skills.

The Instructions:

Make an excel file, with the answers to the questions.

- Make an independent tab for each question, and label the tabs clearly as: Q1, Q2, Q3, Q4, and Q5. The verbal answers should be in the excel file also. When doing the answers, make sure to format the cells by "text wrap." Here is a tutorial:https://www.howtoexcel.org/wrap-text/

On the other hand, you may insert a text box also. Show the work clearly. Label all the inputs. State where you obtained the information from (Table number, exhibit number, page number.)

Questionzero.Professional look: - 10points

Follow the submission instructions which you can see above.

Question one: Project Evaluation: - 20 points

You are working for an athletic shoe manufacturer and have been asked to develop a business case for a new hiking shoe.

To analyze the project and give a recommendation, you have collected the following information:

The life of the project would be three years. Project will start at the end of 2024.

The total revenues of the hiking shoe market is projected to reach $500 million during 2025, and it will growing at a rate of 10% per year.

Your company's market share projections are: 15% in 2025; 18% in 2026; and 20% in 2027.

Your firm would be able to use an idle section of one of its factories to produce the hiking shoe. This section's overhead allocation would amount to $2 million per year. The firm will still incur these costs if the hiking shoes were not produced. In addition, this section would remain idle for the life of the project if the hiking shoe project were not undertaken.

The firm must purchase manufacturing equipment costing $50 million. The cash outlay would be at the end of 2024, and depreciation will start in 2025. Depreciation percentages for the first three years respectively were: 20%, 20%, and 20%.

The equipment will be sold for its book value at the end of the project's life.

The net working capital needs will be 10% of the following year's sales.

Cost of goods sold is expected to be 30% of sales.

General and administrative expenses would be 20% of sales in 2025. This would drop to 10% in 2026 and 8% in 2027.

Advertising and promotion costs would be $5 million each year.

The company's federal plus state marginal tax rate is 30%.

Annual interest costs on the debt for this project would be $600,000.

The estimated the cost of capital for the hiking shoe is 15%.

What is the Net Present Value, Internal Rate of Return and Payback Period of this project? Based on these capital budgeting metrics, what would your recommendation be?

Questions 2,3,4 and 5 are based on the case study Midland Energy Resources, Inc.: Cost of Capital. Please do not use any data/information that is not presented in the case.

QuestionTwo: Weighted Average Cost Of Capital - 20 points

Calculate the WACC estimate for Midland Energy in 2007 using the data presented on Table 1, Table 2, Exhibit 5, and Exhibit 6.

Steps:

a) You are given the beta for Midland Energy for 2006 in the case, which is 1.25. Calculate the adjusted beta.

b) Estimate the cost of equity using the adjusted beta. State your assumptions for the risk-free rate and the market risk premium clearly.

c) Calculate the cost of debt. Again, state your assumptions clearly.

d) Calculate the WACC. Assume that debt and equity levels will not change from 2006 to 2007.

QuestionThree: Financial Leverage AndIts Impact On Cost Of Capital

Next, you will calculate the WACC for the Exploration & Production Division. Exhibit 5 lists the financial information for the peers. You decided that you will use the two largest peers in your calculations.

Steps:

Cost of Equity: Calculate the cost of equity for the Exploration & Production division, using the adjusted betas for the peers. You are told that the D/E ratio of the Exploration & Production Division is 0.4.

Note that you cannot use the average cost of equity of the peers as an estimate for the division. This is because the peers' capital structures are different than Midland's Exploration & Production Division, therefore they are exposed to different levels of financial risk.

You will need to:

(1) Calculate cost of equity for the peers using adjusted betas.

(2) Unlever each peer's cost of equity to take out the impact of peer's financial risk on their cost of equity.

(3) Calculate the average unlevered cost of equity for the peers.

(4) Relever the average unlevered cost of equity for the peers, so the cost of equity estimate reflects the Division's financial risk.

Cost of Debt: Refer to Table 1 and Table 2 to estimate the cost of debt for the Division.

WACC: Now calculate the WACC for the division. Is the Division's WACC higher or lower than the consolidated company's WACC? What may be some of the reasons behind the difference?

Question Four: Optimal Capital Structure

Midland Energy Resources had a separate target debt ratio for each of its divisions. In your opinion, which division should have the highest target debt ratio? Why?

- Please answer this question by using the arguments and predictions of the Trade-off Theory of Capital Structure.

- Please note that your answer to this question may differ from the actual debt policy of the company presented in Table 1, i.e. the targets they have in place may not be the optimal debt ratios!

QuestionFive: Corporate Payout Policy

Please refer to Exhibit 4 in the case when answering this question.

a) The payout policy of Midland Energy consisted of paying regular cash dividends. According to the financial data presented in the case, how did the company decide on the amount of dividend distributions between 2001 and 2006? Did the dividend payments correlate with the company's profitability or stock market performance during those years? Please base your discussion on (1) dividends per share, (2) dividend payout ratio, (3) dividend yield.

b) The company historically conducted share repurchases when the share prices fell below their intrinsic values. The CFO of Midland asked you whether the company should start conducting regular share repurchase programs as a part of their corporate payout policy. Please state at least two reasons to the CFO to persuade them that initiating a share repurchase program is a good strategy going forward.