FIN503 Managerial Finance:Calculating Company Historical Stock Prices

FIN503 Managerial Finance:Calculating Company Historical Stock Prices

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FIN503 Managerial Finance

Question:

Calculating Company’s Historical Stock Prices

Case Study

You were hired as a financial consultant for David & Main Co. which is a publicly traded company that produces luxury watches. The company considers starting a new production line, sport watches, and they need to raise $500 million to fund the new project. Of the $500 million, $300 million will be invested in purchasing a new equipment to manufacture the watches with a lifetime of 5 years.  This equipment is five-year MACRS property for tax purposes and the equipment at the end of the lifetime of the project will be worth half of what it was paid for it.

In addition, the company will have to invest the remaining $200 million in net working capital at the beginning to buy raw materials. The company believes that they can annually sell around 10,000 sport watches at a price of $25,000 per unit, which cost them only $10,000. Fixed costs for the project will run $1,000,000 per year.

The company’s capital structure calls for 60% debt and 40% equity from retained earnings. The company has an outstanding 25 years noncallable bond with a face value of $1,000 and 10% annual coupon rate. The market price for the bond is $1,100 and tax rate is 35%.  The company’s historical stock prices along with the market portfolio (the index) are attached.

If you have the following information:

The return on the market portfolio “index” (Rm) = 8%

The risk-free rate = 2%

Growth rate = 10%

Dividend paid last week = $4

Company’s risk premium = 4% (NOT CAMP RP)

1. What recommendation would you give the management of David & Main Co.? Should they accept the proposed business line (Sport Watches)? Use NPV, IRR, MIRR, Payback Period, and Discounted Payback Period to support your decision.

2. The management of David & Main Co. reviewed your decision, but they have some concerns about sales due to COVID – 19. They explain that due to the pandemic and curfew, sales may not be as expected (might go down) and may not be able to sell 10,000 units. On the other hand, they are now working on improving their online website hoping the increase sales.

Thus, they want to know how your decision is sensitive to changes in sales units if they believe that they would sell 8,000 units in the worst-case scenario and 12,000 unit in the best-case scenario. Would you still give David & Main Co. the same decision you gave earlier? explain.

FIN503 Managerial Finance

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