The Project

It appears that Clinkers Incorporated, a competitor in Edmonton, has been struggling for quite some time. The firm has posted Negative EPS numbers in each of the last three years (-$2.30, -$2.50, -$3.00), and over the three years its Market Capitalization has dropped from $186 Million to $98 Million. Clinkers' Management Discussions & Analysis shows that senior management has become extremely concerned about its Debt Situation (D/E Ratio for 2016 was 2.65, compared to an industry average of 1.35). Market Analysts are predicting that without a serious capital infusion within the next three months, Clinkers Incorporated could be headed for Insolvency.

In 2012 Clinkers Incorporated decided to invest in the creation of a Video on Demand service called Clinkos. The initial investment was expected to be $100 Million, however project overruns resulted in a total investment of $180 Million. Even at the high investment cost, the project was expected to have a high projected return (IRR 12%), The actual returns however have not materialized. In 2016, Clinko's best performance year, the Video on Demand service lost $10 Million.

While Video on Demand has not succeeded for Clinkers Incorporated, the product has seen huge returns for other media entity all over the world. In fact there is a firm belief within BMC that Video on Demand is the future of programming and as such failure to adapt would result in becoming obsolete long term. BMC believes that Clinkers Incorporated made several marketing errors in its promotion of Clinkos that resulted in its failure. Furthermore BMC's Vice President of IT believe that if BMC were to acquire Clinkos, they can upgrade the platform to make it more user friendly and remarket the platform under the Butlers brand name. BMC has started negotiations to acquire Clinkos, and the two companies have agreed on three possible alternatives for the sale of Clinkos Video on Demand Platform..

Alternative 1:

BMC will purchase Clinkos from Clinkers Incorporated at a straight Cash price of $50 Million Dollars. The purchase will be entirely financed by Long Term Debt at a cost of 7%. BMC has an effective tax rate of 40%. To make the platform viable, Upgrades costing a total of $10 Million be required. The upgrades and the investment are not CCA eligible.

Incremental Cash Flows Under this alternative are below. Note: After 18 years it is determined that the Video on Demand will be obsolete with no salvage value.

Years Incremental Cash Flow (Net of All Costs)

1-3 1,000,000

4-10 7,000,000

11-17 10,000,000

18 500,000

Alterative 2:

BMC can lease the platform from Clinkers Incorporated. Clinkers Incorporated will continue to own the Platform, but will no longer offer it under its own brand name. Furthermore, Clinkers Incorporated will pay for the $10 Million dollars in upgrades. The rental cost of the platform will be $5 Million a year paid at the beginning of every calendar year starting in 2018. The lease will be for a 15-year term. In order to administer the program, BMC will have some administration and operating expenses, however all other expenses will be paid by Clinkers Incorporated. Details of the relative cash flows are below. There are no lease renewals.

Years Revenue generated Admin & Operating Cost Lease cost (Paid at beginning of year)

1-3 $6,000,000 $1,000,000 $5,000,000

4-10 $8,000,000 $1,100,000 $5,000,000

11-15 $11,000,000 $1,200,000 $5,000,000

Alternative 3

BMC can evoke on a joint venture with Clinkers Inc. Under this alternative, BMC will offer Clinkers Incorporated a $20 Million initiation fee paid immidiately. The agreement will be for a 10-year term, BMC will not own the asset but rather will be paying for its use upfront. BMC can cancel this partnership agreement at any time, however the $20 Million fee is irrevocable. All upgrade, operating & admin costs will be paid by Clinkers Incorporated. The revenues generated will be the same as Alternative 2. The initiation fee is not eligible for CCA.

REQUIRED

D. The VP of marketing has mentioned concerns regarding negative interdependences to BMC's other line of business such as Cable Television, should it go forward with any of the three alternatives. What analysis can we perform to quantify the VP's concerns?

E. Below has the Net Working Capital changes that will result from the Clinkos Purchase for all alternatives. After the end of each alternative the NWC will return to normal. Determine the NPV impact of the NWC

Increase in Accounts Receivable 2,000,000

Increase in prepaid expenses 1,000,000

Increase in Accounts Payable 1,500,000

F. Recalculate the NPVs for all alternatives considering the Projected Net Working Capital Changes in Part E Recommend the best alternative

G. BMC has another independent project for consideration with an NPV of $10,000,000. That project has an initial investment of $50,000,000. Overall BMC has a capital investment budget of $90,000,000 it must adhere to due to debt covenants. Taking this into account, determine the best alternative