Report to CFO and CEO
MEMO
To: CFO Superior Living
Cc: CEO
From:
Date:
Re: Superior Living Final Report
Message: Below you will find my final finding on Superior Living’s new project report.
In this report I will be addressing the following issues.
‘¢ Financial pros and cons and final recommendations for Superior going public and the new production plant.
‘¢ Discussion on what hurdle rates the production plant project would not pass
‘¢ Debt versus no debt option (associated risk and impact to financial statements)
‘¢ Key financial metrics for the senior management team
In this report I will be using the two spreadsheets that have been provided to me one being Superior Living’s Balance Sheet and Superior Living’s Income Statement. In this report I will be basing all of my information by using metrics for the following.
‘¢ Payback period
‘¢ Net present value
‘¢ Internal rate of return
‘¢ Modified internal rate of return
Financial Pros and cons and final recommendations for Superior going public and the new production plant.
1. What are the financial considerations of an initial public offering (IPO)?
(1) The first issue is dealing with the current state of the Stock Market. With the recent downgrade of the USA from AAA to AA+, the timing of this IPO is in question regarding this aspect (Swann, CFA, August 5, 2011).
(2) The current market for IPOs is not as comfortable as it was even a short time ago. Investors are not comfortable with new companies, or additional risk. There is some additional looking into innovative companies, but with extreme caution.
(3) The price of the stock would be dependent on the general market for IPOs and the stock market as a whole. This endeavor is not particularly innovative and is subject to the consumer market demand for a good that is produced by a variety of manufacturers and at varying rates, this would indicate that the demand would not exceed supply and this IPO may decline or be significantly less than desired.
2. What are flotation costs?
The flotation costs would most likely be larger than normal due to the market situation, resulting in larger costs to the company and less working capital being brought in.
At this time, with the current market and expected costs, the company should not go public and should finance the project internally. If the market improves or other considerations are evaluated as favorable in the future, the decision can be revisited.
New production plant:
The return on investment in the new project would be beneficial to the company. The payback period is less than 3 years (two years and just less than nine months). The Modified Internal Rate of Return is 18%, with an Internal Rate of Return of 24%. The net present value is $1,429,506. With current cash on hand of $7.8 million, the company is well placed to invest in a new production plant (“Applied Managerial Finance, Phase 3 Individual Project”, 2011,) . However, the current liquid assets are less than the current liabilities. This could result in a cash flow issue if current liabilities become due without a corresponding sale of inventories. Although this is a risk, the gain of expanding and return expected with the new product is an acceptable risk and the company should invest in the new production plant.
Discussion on what hurdle rates the production plant project would not pass
If the production plant is required to have a hurdle rate of 18% or less, this project would pass and should be continued. If the hurdle rate is 19% or more, this project would not be acceptable and should be rejected.
Debt Versus no Debt option (associated risk and impact to financial statements).
As stated above, this project would have an acceptable hurdle rate of 18% or below. The company would increase its long term debt if financing the debt or would see a significant reduction in assets if self-financing. The potential risk of a cash flow issue should be carefully considered. If the project is self-financed, additional lines of credit or sources of credit should be obtained to ensure cash flow is adequate for future operations. If the debt is financed, the cost of capital would be expected to go up based on the increase in long-term debt to the company (“Applied Managerial Finance, Phase 3 Individual Project”, 2011,) .
Key financial metrics for the senior management team.
The payback period for this project is under 3 year with a net present value of $1,429,506. The MIRR is 18% with an IRR of 24%. If the hurdle rate is 18% or less, this project would be acceptable, (“Applied Managerial Finance, Phase 3 Individual Project”, 2011,). The potential for cash flow issues should be carefully evaluated but, with preplanning and securing sources of credit for emergencies, are expected to be manageable. The project should be self-financed as long as sources of credit are secured if needed. If lines of credit or other credit sources are not secured, then the project should be financed by outside institutions. The company should not go public at this time but should evaluate the market in six to twelve months to determine if the stock market and the IPO market has improved and re-evaluate an IPO at that time.
Above reference are based on CTU information, from Superior Living’s Balance Sheet, Income Statement, Excel Spreadsheet Group Project
References
Applied Managerial Finance, Phase 3 Individual Project. (2011). Retrieved from https://campus.ctuonline.edu/pages/MainFrame.aspx?ContentFrame=/Default.aspx
Swann, N. G., CFA (August 5, 2011). United States of America Long-Term Rating Lowered To AA+ On Political Risks And Rising Debt Burden, Outlook Negative. Retrieved from http://www.standardandpoors.com/servlet/BlobServer?blobheadername3=MDT-Type&blobcol=urldata&blobtable=MungoBlobs&blobheadervalue2=inline%3B+filename%3DUS_Downgraded_AA%2B.pdf&blobheadername2=Content-Disposition&blobheadervalue1=application%2Fpdf&blobkey=id&blobheadername1=content-type&blobwhere=1243942957443&blobheadervalue3=UTF-8