CASE ANALYSIS – UNITED CORPORATION LIMITED 140 MARKS
The following comprehensive assessment is based on a continuing case study of United Corporation Limited. The following financial statements have been provided:
United Corporation Limited
Income Statement
For the years ended December 31, 2018 & 2019
2018 (‘000s) 2019 (‘000s)
Sales 750,000 937,500
Cost of Sales (250,000) (255,500)
Selling & Marketing Costs (125,000) (130,000)
Admin. Expenses (45,000) (47,500)
Depreciation Expense (15,000) (17,500)
Earnings before Interest & Taxes 315,000 487,000
Interest Expense (2,500) (2,500)
Taxable Income 312,500 484,500
Taxation (35%) (109,375) (169,575)
Net Income 203,125 314,925
Dividends (40%) 81,250 125,970
Addition to Retained Earnings 121,875 188,955
Additional Information:
Ordinary Share Price 17.50 22.75
Ordinary Shares Outstanding (‘000s) 100,000 120,000
United Corporation Limited
Statement of Financial Position
As at December 31, 2018 & 2019
2018 (‘000s) 2019 (‘000s) 2018 (‘000s) 2019 (‘000s)
ASSETS LIABILITIES & EQUITY
Current Assets Current Liabilities
Inventories 220,000 230,000 Accounts Payables 115,000 95,000
Accounts Receivables 245,000 275,000 Notes Payables 125,750 110,545
Cash & Equivalents 175,750 225,000 240,750 205,545
640,750 730,000
Non-current Liabilites 100,000 75,000
Non Current Assets, Net 525,500 575,000
Total Liabilities 340,750 280,545
Equity
Common Stock 220,000 230,000
Retained Earnings 605,500 794,455
Total Equity 825,500 1,024,455
TOTAL ASSETS 1,166,250 1,305,000
TOTAL LIAB. & EQUITY 1,166,250 1,305,000
Question 1 25 Marks
As part of your analysis, you are required to investigate United Corp.’s cash flows and selected ratios.
Required: Using the financial statements provided on page 1:
(a) Compute the following ratios for United Corp. for 2018 and 2019:
i. Return on Equity using Du Pont Identity (6 Marks)
ii. Earnings Per Share (EPS) (2 Marks)
iii. Price/Earning (P/E) Ratio (2 Marks)
iv. Book Value Per Share (3 Marks)
v. Market-to-Book Ratio
(b) Calculate the following for 2019: (2 Marks)
i. Operating Cash Flow (1 Mark)
ii. Net Capital Spending (1 Mark)
iii. Change in Net Working Capital (2 Marks)
iv. Cash Flow from Assets (2 Marks)
v. Cash Flow to Creditors (2 Marks)
vi. Cash Flow to Stockholders
(2 Marks)
Question 2 20 Marks
Utilize the 2019 financial statements for United Corporation Limited provided on page 1 and assume that the company is currently operating below capacity, at 85%.
Required: Prepare Pro-Forma statements for 2020 (rounding all figures to the nearest dollar) assuming:
? All costs/income/expenses and net working capital vary directly with sales/revenue.
? No new equity is raised.
? Sales are projected to increase by 12%
? The tax rate and the dividend payout ratio will remain constant.
? Interest Expense and Depreciation Expense will remain unchanged.
Clearly state if United Corp. will require external financing or would have excess financing in
2020, and how much. (20 Marks)
Question 3 20 Marks
(a) United Corp. is considering issuing a $15,000,000 10-year bond in early 2021, with an annual coupon rate of 8%, and quarterly interest payments.
Required:
If the company anticipates that the yield to maturity on the date of issue is expected to be 10%,
given the company’s credit ratings and current market conditions, how much would an investor be
willing to pay for $1,000 face value of this bond? (7 Marks)
(b) United Corp. is also considering a Class B issue of its common stock on the market via an Initial Public Offering (IPO) in early 2021. The company is expected to pay the following dividends over the next 4 years: $1.50, $2.00, $3.00, $3.50. Thereafter, the company is expected to increase dividends by an annual rate of 5%.
Required: Assuming investors would require a return of 13% on this riskier type of investment, how much would an investor pay for this share today? (10 Marks)
(c) United Corp. is also assiduously finalising the issuance of its preference shares. The company plans to pay an annual dividend of $5.00 on each preferred share and anticipates investors required return to be around 10%.
Required: Compute the price at which United Corp. should issue these preferred shares.
(3 Marks)
Question 4 20 Marks
Having successfully issued their preference shares, United Corp. is seeking to determine its Weighted Average Cost of Capital, so that it can be used as the company’s required return in evaluating upcoming capital projects.
Utilising information from United Corp.’s financial statements, presented on page 1, together with current information, the company has the following capital structure:
Debt:
Bonds outstanding has a face value of $75,000,000, currently selling at 110% of par. The coupon rate on these bonds is 8% and there is 15 years left to maturity. (Hint: you can use the lowest multiple of $1,000 for the YTM calculation only)
Common stock:
120,000,000 shares of common stock outstanding with a market price of $20.00.
Preferred stock: 10,000,000 shares of preferred shares outstanding with a market price of $52.63. The annual dividend is $5.00.
Additional Information:
? The Company’s tax rate is 35%.
? The current risk free rate is 3.50%; market return is 10%. ? The Company’s beta is 1.40.
Required: Calculate the Weighted Average Cost of Capital for United Corporation Limited.
(20 Marks)
Question 5 25 Marks
Based on the Weighted Average Cost of Capital calculated in question 4, United Corp. decides to use a rounded minimum required return of 12%; which it has decided to use for the following capital budgeting evaluation scenario:
The company is considering whether to purchase the Basic or Premium version of the AR5 machine, a key piece of equipment that is expected to improve efficiency of daily operations.
You have been tasked with evaluating the quantitative aspects of the projects, which are mutually exclusive. The projected cash flows of both projects are as follows:
Years Project
Basic AR5 Premium AR5
0 (5,000,000) (7,500,000)
1 1,000,000 2,500,000
2 1,500,000 2,500,000
3 2,000,000 2,500,000
4 2,250,000 2,500,000
As noted above, the company has a required rate of return of 12%. The following PV factors are provided:
Year PV Factor (12%)
1 0.8929
2 0.7972
3 0.7118
4 0.6355
Required:
(a) Evaluate the projects using each of the following criteria, stating which project(s) United Corp.
should choose under each criteria and why:
i. Payback (4 Marks) ii. Discounted Payback (8 Marks) iii. Net Present Value (4 Marks) iv. Profitability Index (3 Marks)
(b) Compute the Internal Rate of Return (IRR) for the Premium AR5 machine only, given that it falls between 12% and 13%. The PV Factors for 13% are provided below: (6 Marks)
Year PV Factor (13%)
1 0.8850
2 0.7831
3 0.6931
4 0.6133
Question 6 30 Marks
In addition to the projects evaluated above, United Corp. is considering several other savings and financing options in an effort to expand operations and improve overall efficiency of operations, while fully investing idle cash.
(a) Based on Statement of Financial Position as at December 31, 2019, the Company had $225,000,000 is Cash & Equivalents. Of this, $5,000,000 was in a fixed deposit that is due to mature on December 15, 2020. The company is considering the following investment options for these funds:
Investment A Annual Interest Rate of 6.5%, compounded semi-annually
Investment B Annual Interest Rate of 6.25%, compounded monthly
Investment C Annual Interest Rate of 6.55%, compounded annually
Required:
i. Advise the company on the best investment option for the maturing funds. (Hint: EAR)
(6 Marks)
ii. Based on your choice from part (i), if United Corp. invests the lump sum on $5,000,000 on December 16, 2020 and leaves it in the account for 2 years, what will be the value of the
investment on December 15, 2022? (4 Marks)
(b) The company is considering purchasing a new delivery truck for $2,000,000. The intention is to obtain a 5-year loan from their bank, at an interest rate of 9% per annum. Annual payments are expected to be made on the loan.
Required:
i. Calculate United Corp.’s annual payment on this loan. (5 Marks)
ii. Prepare the 5-year Amortization Schedule for this loan, clearly showing the interest and principal payment annually. (5 Marks)
(c) As part of being a responsible corporate citizen, United Corp. wants to establish a college fund to assist under-privileged students in pursuing their 4-year under-graduate degree programmes. The tuition fee is estimated to be $75,000 for the first year but is expected to grow/increase by 4% per year thereafter.
Required:
i. Assuming this college fund will earn 8% interest per annum, calculate the amount required at the start of a student’s college journey to fund his/her full tuition. (5 Marks)
ii. If United would like to sponsor the first student in two years’ time and they currently have $225,000 earmarked for investment, what annual rate of interest is required to accumulate
the amount needed as calculated in part (i)? (5 Marks)
