Seth Bullock, the owner of Bullock Gold Mining is evaluating a new gold mine in South Dakota. Dan Dority, the company’s geologist, has just finished his analysis of the mine site.

Seth Bullock, the owner of Bullock Gold Mining is evaluating a new gold mine in South Dakota. Dan Dority, the company’s geologist, has just finished his analysis of the mine site.

Seth Bullock, the owner of Bullock Gold Mining is evaluating a new gold mine in South Dakota. Dan Dority, the company’s geologist, has just finished his analysis of the mine site.

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Corporate Finance Management

ATTEMPT ONLY FOUR CASE STUDY

CASE 1: The McGee Cake Company

In early 2001, Doc and Lyn McGee formed McGee Cake Company. The company produced a full line of cakes, and its specialties included chess cake, lemon pound cake, and double-iced, double-chocolate cake. The couple formed the company as an outside interest, and both continued to work at their current jobs. Doc did all the baking, and Lyn handled the marketing and distribution. With good product quality and a sound marketing plan, the company grew rapidly. In early 2006, the company was featured in a widely distributed entrepreneurial magazine. Later that year, the company was featured in Gourmet Desserts, a leading specialty food magazine. After the article appeared in Gourmet Desserts, sales exploded, and the company began receiving orders from all over the world.

Because of the increased sales, Doc left his other job, followed shortly by Lyn. The company hired additional workers to meet demand. Unfortunately, the fast growth experienced by the company led to cash flow and capacity problems. The company is currently producing as many cakes as possible with the assets it owns, but demand for its cakes is still growing. Further, the company has been approached by a national supermarket chain with a proposal to put four of its cakes in all the chain’s stores, and a national restaurant chain has contacted the company about selling McGee cakes in its restaurants. The restaurant would sell the cakes without a brand name.

Doc and Lyn have operated the company as a sole proprietorship. They have approached you to help manage and direct the company’s growth. Specifically, they have asked you to answer the following questions:

1.                   What are the advantages and disadvantages of changing the company organization from a sole proprietorship to an LLC?

2.                  What are the advantages and disadvantages of changing the company organization from a sole proprietorship to a corporation?

3.                  Ultimately, what action would you recommend the company undertake? Why?

CASE 2: Ration Analysis at S&S Air, Inc.

Chris Guthrie was recently hired by S&S Air, Inc., to assist the company with its financial planning and to evaluate the company’s performance. Chris graduated from college five years ago with a finance degree. He has been employed in the finance department of a Fortune 500 company since then.

S&S Air was founded 10 years ago by friends Mark Sexton and Todd Story. The company has manufactured and sold light airplanes over this period, and the company’s products have received high reviews for safety and reliability. The company has a niche market in that it sells primarily to individuals who own and fly their own planes. The company has two models; the Birdie, which sells for $53,000, and the Eagle, which sells for $78,000.

Although the company manufactures aircraft, its operations are different from commercial aircraft companies. S&S Air builds aircraft to order. By using prefabricated parts, the company can complete the manufacture of an airplane in only five weeks. The company also receives a deposit on each order, as well as another partial payment before the order is complete. In contrast, a commercial air-plane may take one and one-half to two years to manufacture once the order is placed.

Mark and Todd have provided the following financial statements. Chris has gathered the industry ratios for the light airplane manufacturing industry.

S&S Air, Inc. 2006 Income Statement

Sales                                                   $21,785,300 Cost of goods sold                                15,874,700 Other expenses                                        2,762,500 Depreciation                                               976,200 EBIT                                                     $ 2,171,900 Interest                                                        341,600 Taxable income                                    $ 1,830,300 Taxes (40%)                                                732,120 Net income                                            $ 1,098,180 Dividends                           $439,272 Add to retained earnings      658,908

S&S Air, Inc. 2006 Balance Sheet
Assets                                                   Liabilities and Equity
Current assets Cash Account receivable Inventory Total current assets Fixed assets Net plant and equipment Total assets	$     315,000        506,000        740,800 $  1,561,800   $11,561,000 $13,077,800	Current liabilities Accounts payable Notes payable Total current liabilities Long-term debt Shareholder equity Common stock Retained earnings Total equity Total liabilities and equity	$   635,000   1,450,000 $2,085,000 $3,800,000 $    250,000    6,942,800 $ 7,192,800 $13,077,800

Light airplane Ratios
	Lower Quartile	Median	Upper Quartile
Current ratio Quick ratio Cash ratio Total asset turnover Inventory turnover Receivables turnover Total debt ratio Debt-equity ratio Equity multiplier Times interest earned Cash coverage ratio Profit margin Return on assets Return on equity	0.50 0.21 0.08 0.68 4.89 6.27 0.44 0.79 1.79 5.18 5.84 4.05% 6.05% 9.93%	1.43 0.38 0.21 0.85 6.15 9.82 0.52 1.08 2.08 8.06 8.43 6.98% 10.53% 16.54%	1.89  0.62  0.39  1.38 10.89 14.11  0.61  1.56  2.56  9.83 10.27 9.87% 13.21% 26.15%

Seth Bullock, the owner of Bullock Gold Mining is evaluating a new gold mine in South Dakota. Dan Dority, the company’s geologist, has just finished his analysis of the mine site.

Seth Bullock, the owner of Bullock Gold Mining is evaluating a new gold mine in South Dakota. Dan Dority, the company’s geologist, has just finished his analysis of the mine site.

Questions:

1.                   Using the financial statements provided for S&S Air, calculate each of the ratios listed in the table for the light aircraft industry.

2.                  Mark and Todd agree that a ratio analysis can provide a measure of the company’s performance. They have chosen Boeing as an aspirant company. Would you choose Boeing as an aspirant company? Why or why not? There are other aircraft manufacturers S&S Air could use as aspirant companies. Discuss whether it is appropriate to use any of the following companies: Bombardier, Embraer, Cirrus Design Corporation, and Cessna Aircraft Company.

3.                  Compare the performance of S&S Air to the industry. For each ratio, comment on why it might be viewed as positive or negative relative to the industry. Suppose you create an inventory ratio calculated as inventory divided by current liabilities. How do you think S&S Air’s ratio would compare to the industry average?

CASE 3: The MBA Decision

Ben Bates graduated from college six years ago with a finance undergraduate degree. Although he is satisfied with his with his current job, his goal is to become an investment banker. He feels that an MBA degree would allow him to achieve this goal. After examining schools, he has narrowed his choice to either Wilton University or Mount Perry College. Although internships are encouraged by both schools, to get class credit for the internship, neither school will allow its student to work while enrolled in its MBA program.

Ben currently works at the money management firm of Dewey and Louis. His annual salary at the firm is $50,000 per year, and his salary is expected to increase at 3 percent per year until retirement. He is currently 28 years old and expects to work for 35 more years. His current job includes a fully paid health insurance plan, and his current average tax rate is 26 percent. Ben has a savings account with enough money to cover the entire cost of his MBA program.

The Ritter College of Business at Wilton University is one of the top MBA programs in the country. The MBA degree requires two years of full-time enrollment at the university. The annual tuition is $60,000, payable at the beginning of each school year. Books and other supplies are estimated to cost $2,500 per year. Ben expects that after graduation from Wilton, he will receive a job offer for about $95,000 per year, with a $15,000 signing bonus. The salary at this job will increase at 4 percent per year. Because of higher salary, his average income tax rate will increase to 31 percent.

The Bradley School of Business at Mount Perry College began its MBA program 16 years ago. The Bradley School is smaller and less well known than the Ritter College. Bradley offers an accelerated one-year program, with a tuition cost of $75,000 to be paid upon matriculation. Books and other supplies for the program are expected to cost $3,500. Ben thinks that he will receive an offer of $78,000 per year upon graduation, with a $10,000 signing bonus. The salary at this job will increase at 3.5 percent per year. His average tax rate level of income will be 29 percent.

Both schools offer a health insurance plan that will cost $3,000 per year, payable at the beginning of the year. Ben also estimates that room and board expenses will cost $20,000 per year at both schools. The appropriate discount rate is 6.5 percent.

Questions

1.                   How does Ben’s age affect his decision to get an MBA?

2.                  What other, perhaps no quantifiable, factors affect Ben’s decision to get an MBA?

3.                  Assuming all salaries are paid at the end of each year, what is the best option for Ben from a strictly financial standpoint?

4.                  Ben believes that the appropriate analysis is to calculate the future value of each option. How would you evaluate this statement?

5.                  What initial salary would Ben need to receive to make him indifferent  attending Wilton University and staying in his current position?

6.                  Suppose, instead of being able to pay cash for his MBA, Ben must borrow the money. The current borrowing rate is 5.4 percent. How would this affect his decision?

CASE – 4        Bullock Gold Mining

Seth Bullock, the owner of Bullock Gold Mining is evaluating a new gold mine in South Dakota. Dan Dority, the company’s geologist, has just finished his analysis of the mine site. He has estimated that the mine would be productive for eight years, after which the gold would be completely mined. Dan has taken an estimate of the gold deposits to Alma Garrett, the company’s financial officer. Alma has been asked by Seth perform an analysis of the new mine and present her recommendation on whether the company should open the new mine.

Alma has used the estimates provided by Dan to determine the revenues that could be expected from the mine. She has also projected the expense of opening the mine and the annual operating expenses. If the company opens the mine, it will cost $500 million today, and it will have a cash flow of $80 million nine years from today costs associated with closing the mine and reclaiming the area surrounding it. The expected cash flows each year from the mine are shown in the table. Bullock Mining has a 12 percent required return on all of its gold mines.

Year	Cash Flow
0 1 2 3 4 5 6 7 8 9	─$500,000,000        60,000,000        90,000,000      170,000,000      230,000,000      205,000,000      140,000,000      110,000,000        70,000,000     ─80,000,000

Question:

1.      Construct a spreadsheet to calculate the payback period, internal rate of return, modified internal rate of return, and net present value of the proposed mine.

2.            Based on your analysis, should the company open the mine?

3.        Bonus question: Most spreadsheets do not have a built-in formula to calculate the payback period. Write a VBA script that calculates the payback period for a project.

CASE 5: The Beta for American Standard

Joey Moss, a recent finance graduate, has just begun his job with the investment firm of Covili and Wyatt. Paul Covili, one of the firm’s founders, has been talking to Joey about the firm’s investment portfolio.

As with any investment, Paul is concerned about the risk of the investment as well as the potential return. More specially, because the company holds a diversified portfolio, Paul is concerned about the systematic risk of current and potential investments. One position the company holds is stock in American Standard (ASD). American Standard manufactures air conditioning systems, bath and kitchen fixtures and fittings and vehicle control systems. Additionally, the company offers commercial and residential heating, ventilation, air conditioning equipment, systems, and controls.

Covili and Wyatt currently uses a commercial data vendor for information about its positions. Because of this, Paul is unsure exactly how the numbers provided are calculated. The data provider considers its methods proprietary, and it will not disclose how stock betas and other information are calculated. Paul is uncomfortable with not knowing exactly how these numbers are being computed and also believes that it could be less expensive to calculate the necessary statistics in-house. To explore this question, Paul has asked Joey to do the following assignments:

1.         Go to finance.yahoo.com and download the ending monthly stock prices for American Standard (ASD) for the last 60 months. Also, be sure to download the dividend payments over this period as well. Next, download the ending value of the S&P 500 index over the same period. For the historical risk-free rate, go to the St. Louis Federal Reserve Web site (www.stlouisfed.org) and find the three-month Treasury bill secondary market rate. Download this file. What are the monthly returns, average monthly returns, and standard deviation for American Standard stock, the three-month Treasury bill, and the S&P 500 for this period?

2.                  Beta is often estimated by linear regression. A model often used is called the market model, which is: Rt ─ R¦t  = αi + Βi  [RMt ─ R¦t] + εt In this regression, Rt is the return on the stock and R¦t  is the risk-free rate for the same period. RMt is the return on a stock market index such as the S&P 500 index. αi is the regression intercept, and Βi is the slope (and the stock’s estimated beta). εt represents the residuals for the regression. What do you think is the motivation for this particular regression? The intercept αi is often called Jensen’s alpha. What does it measure? If an asset has a positive Jensen’s alpha, where would it plot with respect to the SML? What is the financial interpretation of the residuals in the regression?

3.                  Use the market model to estimate the beta for American Standard using the last 36 months of returns (the regression procedure in Excel is one easy way to do this). Plot the monthly returns on American Standard against the index and also show the fitted line.

4.                  When the beta of a stock is calculated using monthly returns, there is a debate over the number of months that should be used in the calculation. Rework the previous questions using the last 60 months of returns. How does this answer compare to what you calculated previously? What are some arguments for and against using shorter versus longer periods? Also, you’ve used monthly data, which are common choice. You could have used daily, weekly, quarter, or even annual data. What do you think are the issues here?

5.   Compare your beta for American Standard to the beta you find on finance.yahoo.com. How similar are they? Why might they be different?

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