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Accounting for Equity Investments

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Accounting for Equity Investments- Assessment 1

Overview –

Complete three exercises in consolidating the financial statements of a subsidiary and parent company. Consolidated financial statements of a subsidiary and parent company are becoming more typical in today’s business world.

By successfully completing this assessment, you will demonstrate your proficiency in the following course competencies and assessment criteria:-

Competency 1: Consolidate financial statement information. Prepare all necessary journal entries for an equity investment. Prepare a consolidated balance sheet for an equity investment. Determine consolidated asset balances for an equity investment. Analyze equity investment accounting methods. Determine retained earnings balances for an equity investment.

Context–

By now, you are probably asking yourself how there can be additional accounting topics that have not been covered in the courses that preceded this one. Those previous courses answered most of the questions facing an individual seeking a career in the accounting field; however, there still remain many unanswered questions.

Financial reporting for business combinations has experienced many changes over the past several years. In December 2007, the Federal Accounting Standards Board (FASB) issued several statements that significantly affected financial reporting for business combinations.

The procedures used to consolidate financial information generated by the separate companies in a business combination are affected by both the passage of time and the method applied by the parent in accounting for the subsidiary; thus, no single consolidation process that is applicable to all business combinations can be identified. Several factors serve to complicate the consolidation process when it occurs subsequent to the date of acquisition.

In all combinations, within its own internal records the acquiring company will use a specific method to account for the investment in the acquired company. For combinations being consolidated after the acquisition date, certain procedures are required.

Question to Consider

To deepen your understanding, you are encouraged to consider the questions below concerning the equity method of accounting for investments and discuss them with a fellow learner, a work associate, an interested friend, or a member of the business community.

What methods are available to account for investments by one company in another?
How are costs matched against revenues from these investments?
What does the Financial Accounting Standards Board (FASB) have to say about accounting for investments?
Why use the equity method versus the fair-value method to account for said investments?
Although the equity method is a generally accepted accounting principle (GAAP), recognition of equity income has many critics. –
What problems could opponents of the equity method identify?
Which managerial incentives could influence a firm’s percentage ownership interest in another firm?

Resources –

The following resources are required to complete the assessment.

– Accounting for Equity Investments Excel Workbook.

Resources

– Carmichael, D. R., & Graham, L. (2012). Accountants’ handbook, volume 1: Financial accounting and general topics (12th ed.). Hoboken, NJ: John Wiley & Sons.

– Chapter 8, “Accounting for Business Combinations.”
Chapter 9, “Consolidation, Translation, and the Equity Method.”

Flood, J. M. (2014). Wiley GAAP 2014: Interpretation and application of generally accepted accounting principles (12th ed.). Hoboken, NJ: John Wiley & Sons.

Chapter 2, “ASC 205 Presentation of Financial Statements.”
Chapter 20, “ASC 323 Investments—Equity Method and Joint Ventures.
“Chapter 45, “ASC 805 Business Combinations.”
Chapter 47, “ASC 810 Consolidations.”

Hoyle, J. B., Schaefer, T., & Doupnik, T. (2014). Fundamentals of advanced accounting (6th ed.). New York, NY: McGraw-Hill Education.

Chapter 1, “The Equity Method of Accounting for Investments.”
Chapter 2, “Consolidation of Financial Information.”
Chapter 3, “Consolidations – Subsequent to the Date of Acquisition.”

Hoyle, J. B., Schaefer, T., & Doupnik, T. (2014). Fundamentals of advanced accounting (6th ed.). New York, NY: McGraw-Hill Education.

Chapter 1, “The Equity Method of Accounting for Investments.”
Chapter 2, “Consolidation of Financial Information.”
Chapter 3, “Consolidations – Subsequent to the Date of Acquisition.”Complete Exercises 1, 2, and 3 in the Accounting for Equity Investments Excel Workbook, linked in the Required Resources for this assessment.

All financial information and applicable instructions are provided in each exercise worksheet.

Exercise 1: Journal Entries Prepare all necessary journal entries for an equity investment.

Exercise 2: Consolidated Balance Sheet Prepare a consolidated balance sheet for an equity investment.

Exercise 3: Consolidated Balances Determine consolidated asset balances for an equity investment. Analyze equity investment accounting methods. Determine retained earnings balances for an equity investment.

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Shareholder Value Creation Case Study

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Shareholder Value Creation

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Case 5: Genzyme and related investors:

Objective of this case

The case focuses on corporate governance issues by discussing how the objectives of a large activist shareholder can potentially conflict with the core vision of the target company’s management.
Learning how capital investment and payout policy decisions can affect shareholder value creation.
The case offers an opportunity for discussion on how board composition and executive compensation may help align management with shareholders’ interests in a public company.
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Shareholder Value Creation

Summary of case 5

Genzyme reached record revenues of $4.6 billion in 2008 and was expected to generate an increasing level of free cash flow in coming years. But operational problems in one manufacturing plant had led to a warning letter in late February 2009 from the U.S. Food and Drug Administration (FDA), which, combined with news on impending health care reform, had pushed Genzyme’s stock price from a high of $70.42 down to a low of $56.38.

Genzyme was being targeted by Relational Investors (RI), an “activist” investment fund that had a 2.6% stake in the company at the end of March 2009. RI had a history of engagements with the boards of numerous companies that, in several instances, resulted in the CEO’s forced resignation.

Ralph Whitworth, RI cofounder and principal, met with Termeer and delivered a presentation, arguing that Genzyme was trading at a discount.

He offered recommendations on how Genzyme could address this:

(1) improve capital allocation decisions;

(2) implement a share-buyback or dividend program;

(3) improve board composition by adding more members with financial expertise; and

(4) focus executive compensation on performance metrics.

Shareholder Value Creation

Table 1

		Data in Case:
What’s a biotech company?	Rare diseases/genetic disorders/small populations FDA approval (expensive/slow/low probability)	Case pgs. 2–3
How do you succeed?	Orphan drug (seven-year exclusive) Intensive R&D/strong pipeline	Case pgs. 2–3 Case Exhibit 4
Genzyme’s business model	Diversified: segments (GD-CR-BI-HO) GD CR BI HO Other % revenues 53% 22.8% 10.6% 2.4% 11.1% CFROI 25.8% 8.8% Acquisitions ($ million 97–07) 12 1,943 942 2,081 596 Free cash flows (funding acquisitions): expected to grow	Case Exhibit 7 Case Exhibit 8 Case Exhibit 6 Case Exhibit 13
Genzyme’s financial strategy	No dividends and open-market repurchases (some competitors do!) No debt	Case p. 6 Case Exhibits 1 and 4

GENZYME AND RELATIONAL INVESTORS:

SCIENCE AND BUSINESS COLLIDE?

Table 2

		Data in Case:
What is Relational Investors?	Activist investor (vs. Carl Icahn or others?) Engagement battles (% acquired, changes, length of stay?) Performance	Case Exhibits 10 and 11 Case Exhibit 9
Keys to success?	Industry expertise—CFROI analysis Focus: corporate governance Quick turnover: invest, make changes, exit!	Case Exhibit 8
Why target Genzyme?	Intrinsic vs. market value Free cash flow Focus on GD—CFROI 2.6% stake—is that a lot? other shareholders?	Case Exhibit 12 Case Exhibit 13 Case Exhibits 7 and 8 Case Exhibits 2 and 11

Shareholder Value Creation

GENZYME AND RELATIONAL INVESTORS: SCIENCE AND BUSINESS COLLIDE?

Table 3

Issue	Relational Investors’ Criticisms	Genzyme’s Defense	What Happened?
Capital allocation	Diversification outside GD (case Exhibit 6) is destroying shareholder value because non-GD segment’s CFROI low (case Exhibit 8).	Diversification is necessary and investments in biotech take long time to pay back.	Capital allocation committee (chaired by Whitworth); hold on new acquisitions; sale of genetics testing business (2010-Q3).
Share repurchase	FCF should be returned to shareholders in buybacks (see other firms—case Exhibit 4) when internal use generating less than cost of capital (case Exhibit 8).	Need FCF to make long-term investments.	Announcement of $2 billion open-market share buyback program and debt issue (2010-Q2).
Board composition	Need new board members with finance and accounting backgrounds.	Termeer needs board on his side in case of fight (as with Icahn in 2007).	Added to board: Bertolini, Whitworth, one Icahn director (Burkaroff) and two independent directors. (Exhibit TN5)
Executive pay	Incentives are based on revenue generation and not profitability.	Sensitive subject for Termeer and board.	Revised bonus incentive structure

Assignment of case 5

What is the business model for Genzyme? What does Termeer want for his company going forward?

See table 1 of case 5 in the case reading file

What is the business model for Relational Investors?

See the table 2 in the case reading file

Should Termeer fight Whitworth?

a. Or can Termeer manage him by agreeing to some of Whitworth’s demands but avoid giving into demands that might compromise the core mission of Genzyme?

b. If so why? How might those changes improve or adversely affect the company and performance?

See the table 2 in the case reading file

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Shareholder Value Creation Case Study Essay

Case 5

The business model is the treatment aiming at individuals with genetic diseases. Genzyme’s business model is diversified with five segments namely: GD, CR, BI, HO and other. Percentage revenue generated by GD, CR, BI, HO and other are….

What is the business model to the rational investor?

The business model of Rational Investor is concerned with profits and rational investor aims at companies with bad…

Should Termeer fight Whitworth?

Termeer should try to create a compromise for both his key missions for…..

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Investment Banks and Financial Institutions

Investment Banks & Financial Institutions

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Investment Banks and Financial Institutions

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Investment Banks and Financial Institutions

1. Answer questions 4-8 in the attached document.
2. Answer Problems 35, 37, 39, and 41 in the attached documents then answer them again using the below scenarios.
3. Redo problem 35, assuming a coupon rate of 8% in part a, and yields to maturity of 12 and 12.5% in part b ?
4. Repeat problem 37, assuming that the zero coupon bond has 7 years to maturity.
5. Repeat problem 39, assuming that the three bonds under consideration have 6 years to maturity.
6. Repeat problem 41, assuming that the fair present value rose from $975 to $ 990.

Investment banking is the division of a bank or financial institution that serves governments, corporations, and institutions by providing underwriting (capital raising) and mergers and acquisitions (M&A) advisory services. Investment banks act as intermediaries between investors (who have money to invest) and corporations (who require capital to grow and run their businesses).

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Investment Banks and Financial Institutions

PART 1
Questions 4 to 8
Question 4
Identify whether a bond will be considered a premium bond, a discount or a par bond
a) A bond with a market price higher than its par value is a premium bond
b) A bond with a coupon rate equals to its yield to maturity is considered a par bond
c) A bond with a coupon rate less than the required rate of return is considered a discount bond
d) A bond whose coupon rate is less than its yield to maturity is considered a discount bond
e) A bond whose coupon rate is greater than its yield to maturity is considered a premium bond
f) a bond whose fair value is less than its face value is considered a discount bond

Question 5
How equity valuation differ from bond valuation
Valuation of equity onsiders dividend on stock, growth rate, rate of return. These considerations are appropriate where an entity uses dividend growth model
formular where dividend growth factor is equal throughout: Po = D1/r – g
where dividend growth factor is not equal: Po = {Dn (1 + gn)/r – g} (1/(1 + r)n)
Valuation of bond considers bond coupon rate, investors required rate of return, maturity value and maturity period
Formulae = (Intr x PVAF) + (MV x PVIFrn)

Question 6
What happens to the fair present value of a bond when the required rate of return on the bond increases
An increase in required rate of return lowers the fair present value of a bond

Question 7
A change in interest rate affects the price of of both short and long because change in interest rate affects the yield of both and long and short-term loan
Long-term bond’s price is more affected by increase in interest rate due to long duration they cove

Question 8
Bond’s price with large coupon rate are affected with the change in interest rates more than bond’s price with a small interest rate.
This is because large coupon rate reduces bond’s price by a larger margin.

Investment Banks and Financial Institutions

PART 2
Aswer problems
Problem 35
a) what is the duration of a five year treasury bond with a 10% semi-annual selling at per
periods = 2 x 5 years = 10 periods
par value= $1000
coupon = 10%/2 = 5%
interest = 5% x 1000 = 50
bond = (50 x PVIF 10 periods @ 5%) + (1050 x PVIF10 periods @5%) =
= 47.62 + 952.38 X10 = $9571.42
Price = 952.38 + 47.62 = $1000
period = 9571.42/1000 = 9.57/2 = 4.78

b) duration if the yield to maturity increases to 14% and 16%
1st period interest 14% x 1000 x 1/1+0.14 = 122.81
2nd (140 + 1000 ) x 0.7695 = 877.19
(877.19 x 10 ) + 122.81 = $8894.71
price = 1000
8894.71/1000 = 8.89/2 = 4.4 YEARS

At 16%
1st period interest 16% x 1000 x 1/1+0.16 = 137.93
2nd (160 + 1000 ) x 0.7432 = 862.07
(862.07 x 10 ) + 137.93 = $8758
price = 1000
8758.62/1000 = 8.75/2 = 4.3 years

c) Conclusion
An increase in bond yield to maturity reduces the duration of a bond. This is because an increased yield to maturity increases the cash inflow hence reducing the period of maturity

Problem 37
Duration of zero coupon bond that has eight years to maturity
The duration of a bond with a zero coupon rate is the same its maturity date. Thus the duration of the bond is 8 years
if the duration of maturity increases to 10 years, bo nd duration will be 10 years
if the maturity increases to 12 years, bond duration will be 12 years

Problem 39

a) At 8%
interest = 8% x 10000 = 800
1st 800 x 0.9259 = $740.74
2nd (800 + 10000) x 0.8573 = 9259.26
total = (9259.26 x 5) + 740.74 = $47036.29/10000 = 4.7 years

b) at 10%
interest = 10% x 10000 = 1000
1st 1000 x 0.9091 = $909.10
2nd (1000 + 10000) x 0.8264 = 9090.91
Total = (9090.91 x 5) + 909.1 = $46363.65/10000 = 4.6 years

c) coupon rate 12%
interest = 12% x 10000 = 1200
1st 1200 x 0.8929 = $1071
2nd (1071 + 10000) x 0.7972 = 8825.73
Total = (8825.73 x 5) + 1071= $45199.67/10000 = 4.5 years

Problem 41
At 9.75%
interest = 9.75% x 975 = $95.06

at 9.25%
interest = 9.25% x 995 = $92.04
995/92.04 = 974/95.06 = 10 years

Investment Banks and Financial Institutions

PART 3
Problem 35
a) Coupon rate of 8%
interest = 8% x 1000 = 80
1st 80 x 0.9259 = $74.07
2nd (80 + 1000) x 0.8573 = 925.92
total = (925.92 x 5) + 74.07 = $4703.63/10000 = 4.7 years

b) yield to maturity is 12%
interest = 12% x 1000 = 120
1st 120 x 0.8929 = $107.1
2nd (107.1 + 1000) x 0.7972 = 882.57
Total = (882.57 x 5) + 107.1= $4519.96/1000 = 4.5 years

Yield to maturity is 12.5%
interest = 12.5% x 1000 = 125
1st 125 x 0.8889 = $111.1
2nd (111.1 + 1000) x 0.7901 = 877.91
Total = ( 877.91 x 5) + 111.1= $4500.63/1000 = 4.5 years

Investment Banks and Financial Institutions

PART 4
Problem 37
Duration of zero coupon bond that has seven years to maturity
The duration of a bond with a zero coupon rate is the same its maturity date. Thus the duration of the bond is 7 years
if the duration of maturity increases to 10 years, bo nd duration will be 10 years
if the maturity increases to 12 years, bond duration will be 12 years

PART 5
Repeat problem 39,assuming that the three bonds under consideration have 6 years to maturity.

a) At 8%
interest = 8% x 10000 = 800
1st 800 x 0.9259 = $740.74
2nd (800 + 10000) x 0.8573 = 9259.26
total = (9259.26 x 6) + 740.74 = $56296.3/10000 = 5.6 years

b) at 10%
interest = 10% x 10000 = 1000
1st 1000 x 0.9091 = $909.10
2nd (1000 + 10000) x 0.8264 = 9090.91
Total = (9090.91 x 6) + 909.1 = $55455.37/10000 = 5.5 years

c) coupon rate 12%
interest = 12% x 10000 = 1200
1st 1200 x 0.8929 = $1071
2nd (1071 + 10000) x 0.7972 = 8825.73
Total = (8825.73 x 6) + 1071= $54025.38/10000 =5.4 years

Investment Banks and Financial Institutions

PART 6
Repeat problem 41, assuming that the fair present value rose from $975 to $ 990

duration = 990/9.25 = 10.7 years

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The Warren Buffet investment philosophies

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The Warren Buffet investment philosophies

1) Explain the Warren Buffett investment philosophies. Do you agree with them?

2) Calculate IRR of investment in Mid-American Corp. Finish the excel spread sheet in the attached excel file.

3) As for the investment of PacifiCorp, answer the following questions:

1. What does the stock market seem to be saying about the acquisition of PacifiCorp by Berkshire Hathaway?

Pay attention that stock prices are the present value of expected cash flows. How do the investors (shareholders) respond to the PacifiCorp announcement?

2. Based on your own analysis, what do you think PacifiCorp was worth on its own before its acquisition by Berkshire?

Does the bid price seem to be a fairly full-price offer for PacifiCorp? First estimate the implicit value of PacifiCorp with the information in exhibit 9 and 10 and compare the acquisition offer: 9.4 (4.3+5.1) billion.

3. Is the PacifiCorp acquisition a good or bad deal? Why?

The main contradiction is the full price and the positive market reaction to the announcement.

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The Warren Buffet investment philosophies

Warren E. Buffett, CEO of Berkshire Hathaway, is among the top-notch modern-day investors. He uses a classic approach to investing based on fundamental foundations learned from Robert Graham. Some of the core investment policies that Buffett uses ensure Berkshire strategically and critically analyzes an investment before committing. Buffett’s fundamental principle is that he has to have sufficient understanding of the business in order to invest.

In addition, it has to be a favorable choice in terms of the operational strategy, returns, long-term prospects, and leadership (Lane, 2017; John, 2016). For acquisitions, Buffett, as well as Berkshire prefer large purchases with consistent earning power, high ROE and low debt. This is in addition to a sensible price and an efficient management already in place.

The fundamental principles applied by Buffett in analyzing potential investments are a worthy breakdown of business investing. In this case, the use of this analysis is important is separating the worthwhile investments from the rest. In this approach, Buffett uses value investing as opposed to the growth investing methodology used by most investment bankers and analysts.

When compared, the cyclical period sometimes places some benefits on growth investing. However, by following the principles advocated by Buffett, and taking the purchases as long-term investments, one is sure to get better returns. Therefore I do agree with Buffett’s principles owing to the tangible benefits they beget.

The IRR of investment in MidAmerican Corp in the attached spreadsheet is 57.68%. A crosscheck with Calculate Stuff results in an IRR of 55.51%.

The stock market and the acquisition of PacifiCorp by Berkshire Hathaway

Using the stock market as an indicator, the acquisition of PacifiCorp by Berkshire Hathaway is a welcome move that yielded sufficient gains. The price purchase of $5.1 billion has created value as indicated by the share price movements. The stock price for PacifiCorp increased from a low of $113 in January 2013 to a high of $165 in January 2017 and a current share price of $145. As such, the share price metric indicates that the acquisition of PacifiCorp was a worthwhile investment.

Investors (shareholders) respond to the PacifiCorp announcement

Investors’ response to the deal to acquire PacifiCorp indicates their confidence in the value the utility firm will create for Berkshire Hathaway Energy. The deal increases the market value of Berkshire, and possibly the share price as well. This implies an increase in such additional valuations as the price to earnings. In addition, given Buffett’s investing philosophy, he is definitely getting a favorable price for it as compared to the market value of the firm….

Warren Buffet investment philosophies

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Investment Management Questions

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Investment Management

Assume that the company is announcing an unexpectedly large dividend to its shareholders. In an efficient market without information leakage, one might expect:
Which one of the following would provide evidence against the semi strong form of the efficient market theory?
According to the efficient market hypothesis:
A “random walk” occurs when:
A market anomaly refers to:

In an efficient market, professional portfolio management can offer all of the following benefits except:
“Highly variable stock prices suggest that the market does not know how to price stocks.” Respond.
Which of the following sources of market inefficiency would be most easily exploited?
Dollar-cost averaging means that you buy equal dollar amounts of a stock every period, for example, $500 per month. The strategy is based on the idea that when the stock price is low, your fixed monthly purchase will buy more shares, and when the price is high, fewer shares. Averaging over time, you will end up buying more shares when the stock is cheaper and fewer when it is relatively expensive. Therefore, by design, you will exhibit good marketing timing. Evaluate this strategy.

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Banking and Financial Institutions

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Banking and Financial Institutions

Question 1

Capital markets refer to the financial markets where debt and equity instruments with maturities of more than one year are traded. Bond markets are part of the capital markets…

Question 2

T-bills are a short term financial instrument used by the government to source for revenue in order to cover for shortfalls. They are sold through an auction, issued in multiples of $1000…

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Question 3

A STRIP (Separate Trading of Registered Interest and Principal Securities) is a form of a treasury financial security whose…

Question 4

Investing in TIPS bonds has the advantage of having their returns based on…

Question 5

Bearer bonds refer to a type of bond where the coupon is attached to the bond and is, therefore, payable to the…

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The Investment Detective Essay

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The Investment Detective

Case Study

Objective of the case:

This case presents the cash flows of eight unidentified investments, all of equal initial investment size. Your task is to rank the projects. The first objective of the case is to examine critically the principal capital-budgeting criteria.

A second objective is to consider the problem that arises when net present value (NPV) and internal rate of return (IRR) disagree as to the ranking of two mutually exclusive projects.

Finally, the case is a vehicle for introducing the problem created by attempting to rank projects of unequal life and the solution to that difficulty—the equivalent-annuity criterion.

The Investment Detective

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Assignments:

Fill the yellow part of the excel sheet. And then answer the following questions:

1) Which of the two projects, 7 or 8, is more attractive?

a. How sensitive is our ranking to the use of high discount rates?

b. Why do NPV and IRR disagree?

2) What rank should we assign to each project?

a. Why do payback and NPV not agree completely?

b. Why do average return on investment and NPV not agree completely?

c. Which criterion is best?

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3) Are those projects comparable based on NPV?

a. Because the projects have different lives, are we really measuring the “net present” value of the short-lived projects?

4) What is the equivalent-annuity method and when is it called for in project comparisons?

The key points ABOUT capital budget should be the following:

IRR: Possibly incorrect opportunity cost assumption. Violates value additivity. Multiple IRRs are possible.
NPV: May be difficult to explain.
ROI: Often computed on profits, not cash flow. Ignores time profile of flows and the time value of money.
Payback: Ignores time value of money, although it is a proxy for the liquidity or duration of an investment and is sometimes used in conjunction with NPV.

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Banking and Financial Institutions Case Study

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Banking and Financial Institutions Case Study

Hansson Private Label

There is a proposal for a $ 50 million expansion for Hanson Private Label or HPL. HPL manufactured personal care products such as sop, shampoo and mouthwash The proposed expansion is HPL’s response to a retail customer’s desire to expand HPL’s share of their private label manufacturing. Consider the firm’s overall competitive strategy and proceed as follows:

How would you describe HPL and its position within the private label personal care industry ? Use Exhibit 1 to obtain the firm’s profitability, growth rate and leverage (see Exibit 8 as well) versus its competitors.
Estimate the project’s NPV. Would you recommend that Tucker Hanson proceed with the investment ?

Banking and Financial Institutions Case Study

NPV Analysis with Constant Growth

Operating Results

2009 2010 ……..2018

Revenue (Use Exhibit 5)

Less: Raw Material Costs Unit Volume x Raw Materials per unit Exhibit 5

Less Labor Expense Total Labor Cost Exhibit 5

Less: Manufacturing Overhead Exhibit 5

Less: Maintenance Expense Exhibit 5

Less: Selling, General and Administrative Expense .078 x Revenue see Exhibit 5

EBITDA = Earnings before interest, taxes, depreciation and amortization Revenue – Raw Material Costs – Labor Expense – Manufacturing Overhead –Maintenance Expense – Selling, General and Administrative Expense

Banking and Financial Institutions Case Study

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The next line is depreciation. The figure of 4000 is given on p.5 in the table.

Use this figure for each year.

Less: Depreciation expense

EBIT = EBITDA – Depreciation

Less Taxes

Taxes = EBIT x .4

NOPAT

Unlevered Free Cash Flow:

NOPAT

Plus Depreciation

Less: Change in Working Capital

Banking and Financial Institutions Case Study

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For Working Capital, perform this computation

Accounts Receivable/sales/360 = Days Sales Outstanding

Accounts Receivable = Days Sales Outstanding from Exhibit 5 x Revenue from the top line of this chart/360

Accounts Payable= Days Sales Inventory x inventory/360

Days Sales inventory is from Exhibit 5 and inventory is the 2007 figure on page 6.

The next line is unlevered free cash flow. Compute for each year.

Cost of capital: Take any WACC from Exhibit 7’s last column in the second short table such as 9.38%.

Return of Working Capital

Use 3, 147 prior to 2009 and 7,174 in 2018.

From page 3, add facilities expansion, manufacturing equipment and packaging equipment to get the initial investment.

Compute NPV = – Initial investment + PV of an annuity of annual unlevered free cash flows

For payment, use the unlevered free cash flows obtained in this analysis. For i/y, use the cost of capital. For n, count the number of years from 2018 to 2009.

Banking and Financial Institutions Case Study

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Investment Timing

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Investment Timing

The concept of investment timing is directly connected to the business life cycle. These are connected since there is evidence that the stock prices anticipate changes in the business life cycle by period of up to six months at a time (Bodie, Kane, & Marcus, 2013). In this regard, investors will usually perceive changes and act accordingly.

Once they perceive an impending a boom, stocks are purchased since they are not vulnerable to a recession. Once they perceive a downturn, they sell off the stocks and replace their portfolios with fixed income securities. Towards the end of a recession, the investor sells the fixed income securities and replaces them with stocks.

In the case of Universal Auto, and if the assertion by Adam is correct, the ideal time to invest in the stock of the passenger car company would be towards the end of a recession. If as per Adam’s statement, the recovery is underway, the stock should currently be indicative of the better tidings in terms of economic recovery, and this would be the perfect time to purchase the stocks of the passenger car company.

References

Bodie, Z., Kane, A., & Marcus, A. J. (2013). Essentials of Investments. New York: McGraw-Hill/Irwin.

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